Economic and Investment OutlookCIA Conference, TorontoSeptember 2009

Warren A. Thomson

SEVP & Chief Investment Officer

2 2

Overview

Economic Indicators

Canadian Equities

Canadian Fixed Income

Alternative Assets• Commercial Real Estate

• Oil & Gas

• Timber

• Agriculture

3 3

Economic Indicators

4 4

Is The Recession Over?

Signs of growth in China, Europe and Japan in Q2 2009

The US:• Growth may be resuming as we speak (Q3 2009)• Worst downturn since WWII – even a partial rebound could

deliver startling % growth rates• GDP: 2.5% loss vs. 3% trend growth implies at least 5.5%

below potential now

5 5

The Worst Seems To Be Behind UsHome Sales Finding A Bottom

6 6

Initial Unemployment Claims Turn The Corner

7 7

Retail Inventories Still Excessive, But Getting Less So

8 8

ISM Indexes Still Below 50, But Past The Worst

9 9

Canada: Basically Sound, But Tied To The US

Negatives: in a bad neighborhood• Too integrated with the US to avoid tracking US cycle• Spillovers from the demise of Detroit, particularly in Ontario

Positives: living within one’s means• Commodities will bounce back with global growth• Closer than other countries to sustainable budget and trade balances• Systemically important financial institutions are sound

Bottom line: less trauma than elsewhere• Slightly healthier GDP growth than the US• Employment probably not rebounding until 2010• Strengthening CAD may limit manufacturing competitiveness

1010

Canadian Economy Improving

Canada - Leading IndicatorLevel ( ) and %Change Yr/Yr ( )

Source: OECDM1856 JUN 2009

105

100

95

90

85

80

15

10

5

0

-5

-10

-1597 98 99 00 01 02 03 04 05 06 07 08 09 10

87.6

-7.8

)

June 2009

1111

Household Debt Levels Resulting in Paradox of Thrift

))Canada Personal Savings ( ) and Household Debt ( )As Percent of Disposable Income

Consumer credit plus mortgage debtQ239 2009:2

25

20

15

10

5

0

130

120

110

100

90

80

70

60

50

401960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

4.5

128.6

1212

MFC GIM’s Forecast

 2004-08Average

2008 2009Forecast

2010Forecast

Real Economic Growth (% change in GDP)  World 3.5% 2.2% -2.2% 2.6%United States 2.5% 1.1% -2.5% 2.7%Canada 2.4% 0.4% -2.2% 3.0%Eurozone 2.0% 0.6% -4.0% 1.1%Japan 1.7% -0.7% -5.3% 1.6%China 10.8% 9.0% 8.5% 10.0%Inflation (% change in CPI)United States 3.2% 3.8% -0.6% 2.0%Canada 2.1% 2.4% 0.4% 1.9%Eurozone 2.3% 3.2% 0.4% 1.6%Japan 0.2% 1.4% -1.0% 0.0%China 3.6% 5.9% -0.3% 1.1%

Source: MFC Global Investment Management, as at August 24, 2009

1313

Canadian Equities

1414

Commodity Prices Recovering

Commodity Price Indexes

Indexed to 100 at TroughD1039 2 SEP 09

180 180

170 170

160 160

150 150

140 140

130 130

120 120

110 110

100 100Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep

2008 2009

CRB FuturesJournal of CommerceCRB Spot Industrials

September 2009

2008 2009

1515

Equity Valuations are Reasonable

TSX Price-Earnings MultipleBased On Trailing Operating Earnings

Shaded Areas Represent U.S. Economic RecessionsM11 SEP 2009

40 40

35 35

30 30

25 25

20 20

15 15

10 10

5 5

0 01960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Median: 16.7Average: 17.0

15.650-yr Average

September 2009

1616

S&P/TSX Earnings Near Trough

TSX Operating Earnings%Change Year/Year

Bottom-Up Forecast Based on CPMS ConsensusM1301 AUG 2009

60 60

40 40

20 20

0 0

-20 -20

-40 -40

-60 -6096 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

TrailingBottom-Up FcstTop-Down Fcst

-29.0-25.3

27.723.1

18.815.8

August 2009

1717

Earnings Yield Still Above Government Bond Yields

TSX Forward Earnings Yield ( )And Long Term Canada Bond Yields ( )

M1941 SEP 2009

18 18

16 16

14 14

12 12

10 10

8 8

6 6

4 4

2 282 84 86 88 90 92 94 96 98 00 02 04 06 08 10

3.96

6.69

))

September2009

1818

S&P/TSX Bear Markets – 1957 to 2009

Returns from end of bear market

Period # of months Decline 3 months 6 months 12 months 24 months

May 57 – Dec 57 7 -26.9% 7.0% 14.2% 31.2% 37.3%

May 69 – Jun 70 13 -25.4% 13.2% 19.1% 27.5% 45.5%

Oct 73 – Sep 74 11 -35.9% 2.9% 22.1% 23.2% 35.9%

Jun 81 – Jun 82 12 -39.2% 18.7% 46.8% 86.9% 76.3%

Jul 87 – Nov 87 4 -25.4% 8.4% 10.9% 14.5% 42.1%

Dec 89 – Oct 90 10 -20.1% 7.3% 14.8% 18.6% 16.4%

Apr 98 – Aug 98 4 -27.5% 15.2% 15.1% 28.1% 109.4%

Aug 00 – Sep 02 25 -43.2% 7.5% 3.7% 22.5% 45.4%

Median -27.2% 8.0% 15.0% 25.4% 43.8%

Jun 08 – Mar 09 9 -50.2% 39.4% 45.4% ? ?

Source: CPMS/ Bloomberg

1919

Summary

The worst is likely behind us from an equity market perspective

Markets are supported by:• A resumption of global growth• Commodity price recovery• Earnings recovery• Attractive valuations

2020

Canadian Fixed Income

2121

Short Term Rates at Record Lows

Canadian Government Yield Curves

Source: Bloomberg

Post-Crisis (September 9, 2009)

Pre-Crisis (June 30, 2007)

2222

Spread Between LIBOR and T-Bills has Returned to More Normal Levels

Source: Bloomberg

US Interest Rates – September 17, 2004 to September 9, 2009

Lehman failure

Beginning of crisis

3 month US LIBOR3 month US T-Bill

2323

Strong Corporate Bond Returns as of August 31, 2009

Source: PC Bond Analytics, TSX

0.6% 0.2%

3.7%

7.4%

11.5%

-5%

0%

5%

10%

15%

1 month 3 month 1 year

Corporate Federal Government

1.7%

6.4%

11.5%

0.7% 1.0%

5.9%

-5%

0%

5%

10%

15%

1 month 3 month 1 year

Corporate Federal Government

Mid CrisisDecember 31, 2008

Post CrisisAugust 31, 2009

Canadian Bond Total Rates of Return

(0.3%)

2424

Corporate Spread Compression Continues

050

100150200250300350400

Jun 99 Jun 00 Jun 01 Jun 02 Jun 03 Jun 04 Jun 05 Jun 06 Jun 07 Jun 08 Jun 09

Spre

ad (b

ps)

Canadian Investment Grade Corporate Spreads

0200400600800

100012001400160018002000

Jun 99 Jun 00 Jun 01 Jun 02 Jun 03 Jun 04 Jun 05 Jun 06 Jun 07 Jun 08 Jun 09

Spre

ad (b

ps)

US High Yield Spreads

Source: PC-Bond Analytics, Merrill Lynch, June 30, 2009

2525

Canadian Bonds Are Expected to Perform Well Going Forward Interest rates should increase modestly over time

Corporate spreads may tighten further• Modest improvement over time in line with economic

conditions

Corporate bond class should continue to outperform, but relative performance will moderate

2626

Alternative Assets:Prospects and Challenges

2727

Commercial Real Estate

2828

US Market Is Stressed

Most property types and regions experiencing difficulty from increased vacancy and tight credit markets

Office market has settled into a stable but soft cycle

• Duration tied to the start of job creation

Erosion of operating income and valuations is increasing pressure on owners struggling to refinance their loans

Upcoming loan maturities and lower values necessitate new equity

Excessive use of leverage (debt) is the core problem

2929

Canadian Market A Relatively Strong Performer

Market remains relatively healthy compared to rest of the world

Foreign buyers showing interest in acquiring institutional-grade commercial real estate

Concentrated institutional ownership of large properties reduces the likelihood of trades and value declines (due in part to reduced use of leverage)

Pockets of weakness remain contained

3030

Asian MarketOutlook Uncertain

Asia has benefited from financial easing during the first half of 2009

Lower rental rates have resulted from weak space demand and threat of rising vacancy rates

Continued high acquisition activity expected

Property fundamentals remain uncertain into 2010

Risks are lower due to decreased use of leverage relative to rest of world

3131

Oil & Gas

3232

Oil Price Stability Expected to Resume in 2010

Short term oil prices likely to remain volatile• Bloated inventory levels• Tighter oil supply than at start of the year• Some signs of global economic improvement

Oil price stability should replace volatility in 2010• Global economic recovery signs begin to take hold• No suitable substitute for transportation fuel

Source: FirstEnergy Capital, World Crude Oil Markets, August 27, 2009

3333

Natural Gas Price Outlook Remains Weak

Short Term – Natural gas currently challenged by:• High inventories• Weak industrial demand• Growing US domestic production

Long Term – Few catalysts for a rebound in prices• Inventory continues to build• Increasing unconventional supply may insulate price spikes

Weak natural gas prices are a stimulus to the broader economy

Source: BMO Capital Markets, Monthly Commodity Watch, August 2009; IHS CERA – Monthly Briefing “North American Natural Gas”, August 2009

3434

Timber

3535

0200400600800

1,0001,2001,4001,6001,8002,0002,200

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Hous

ing

Star

ts

(100

0 un

its p

er y

ear)

0714212835424956637077

Lum

ber C

onsu

mpt

ion

(b

illion

BF

per y

ear)

Housing Starts Housing Starts Forecast--RISILumber Consumption Lumber Consumption Forecast--RISI

US Housing Starts and US Lumber Consumption

Timber Markets in a Deep Cyclical Trough

Source: Resource Information Systems, Inc. (RISI)

3636

9,000

9,500

10,000

10,500

11,000

11,500

12,000

Q1/05 Q1/06 Q1/07 Q1/08 Q1/09

Mark

et P

ulp

Ship

men

ts

(1

,000

tons

)

0

20

40

60

80

100

120

Glob

al A

vera

ge P

ulpw

ood

Price

(US$

per

ODM

T)

Market Pulp Demand Softwood Pulpwood Price Hardwood Pulpwood Price

Global Pulpwood Demand and Pricing

Demand For Pulp Has Also Declined

Source: Wood Resources International and Hawkins Wright Ltd.

3737

020406080

100120140160180200220240

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Oper

atin

g Ca

sh

02004006008001,0001,2001,4001,6001,8002,0002,2002,400

Prop

erty

Val

ue

Operating Cash Property Value

Sources: NCRIEF and HTRG Research. Methodology detailed in “Explaining Timberland Values in the United States,” Journal of Forestry, December 2004.

Operating Cash and Value for Prototypical All Age US Timberland Property (nominal $ per acre)

Timberland Values Are Stressed

3838

Agriculture

3939

Farmland Market Fundamentals

US farmland values are expected to moderate in near-term and grow in long-term driven by:

• Strong US net farm income

• Healthy balance sheet fundamentals

• Continued strength in the agricultural export markets

4040

Average Value per Acre of US Farmland, 1940–2008

Long-Term Upward Trend in Farmland Value

US Aggregate Net Farm Income (billions), 1940–2018F

Source: USDA Economic Research Service. Actual numbers through 2008, forecast through 2018

4141

Strong Financials and Balance Sheets For the US Farm Sector

Source: USDA Economic Research Service 1970-2008

US Farm Sector Debt Ratios 1970-2008

US Farm Sector Balance Sheet, 1970-2008

4242

Summary

Canada remains sound, but tied to the US

Commodity prices are recovering and equity valuations are reasonable

Short term rates at record lows, with interest rates expected to rise modestly over time

The worst may be behind us, but it is still too soon to declare that the recession is over

Questions & Answers