The Canadian economy should be able to avoid dipping into recession and the U.S. economy may have hit bottom says Canaccord Capital analyst Michael Manford.

“While Canada’s exports have been hammered by the weakness in the United States, the economy continues to crawl along. Canadian consumers are still in stable shape and income growth is surprisingly strong, which should mean a 2-2.5% advance in real spending over the balance of this year. However, inventory levels are far too high and we expect to see some serious trimming in that area over the next two quarters,” says Manford. “Even so, the Canadian economy should easily avoid a recession and grow by about 2.2%-2.4% this year.”

He sees similar inventory cuts ahead in the U.S., too, as its economy rebalances itself. “The U.S. economy is giving off very preliminary signs that the bottom is near. The recent weakness in the manufacturing area has largely been due to inventory paring, which is actually a good sign. We expect that inventories were pared at a heavy pace in the second quarter and will be reduced again in the third quarter, but by a much smaller amount. As a result, we expect to see industrial production start to rise again in the August-September period.”

Through the tough times, U.S. consumers have kept spending. Manford says once the tax cuts hit, spending should rise again too. “That should keep real GDP growth in the 0%-0.5% area in the second quarter and allow as much as 2%-3% growth in the second half of the year.”

With inflation expected to be robust in coming months, and turnaround signs abounding, Manford suggests that we may get another 25 basis points in rate cuts on both sides of the border. “The too high headline inflation rate and a stronger economy likely means that any interest rate cuts in Canada will be confined to about 25 basis points. If employment growth continues to be weak, the Fed may well cut the Funds rate by another 25 basis points, but we think that will be all she wrote,” he says.

Among equities, Manford says the TSE 300 is cheap, apart from tech. “In fact, at present interest rates, earnings could decline by as much as 5% to7% over the next three years and still justify today’s prices. That’s cheap. Even, so we expect that the tech area will take at least until the end of the year to bottom. As a result, the TSE 300 is likely to trade in a wide 7,500-8,200 trading band over the summer months, but push into the 9,000-9,400 area over the fall and winter months.”

“U.S. equity markets are likely to be range bound in the near term around their fair value levels (1,250 for the S&P 500). Earnings growth will be the key to driving markets higher. We suspect that S&P 500 earnings bottomed in the second quarter and will drive 12%-15% higher over the next year. That should allow the S&P 500 to reach the 1,450-1,475 area before the spring.”