The Economy: What’s Next?

Where will the markets go in 2014? What securities should you buy and which should you ignore? Gordon Pape looks into his crystal ball

Perhaps it’s a little early for predictions about what is going to happen to the economy and our investments in 2014. But the folks at the recent World Money Show in Toronto asked me to get out the crystal ball and talk about where Canada is going in 2014. For those who were not able to attend, here’s a summary of what I had to say.

I began by making the point that this is not an easy question to answer. Even the Bank of Canada is not sure about what’s coming. In his remarks at last month’s release of the Monetary Policy Report, new Bank Governor Stephen Poloz said that while the global recovery remains intact, “its near-term dynamic has changed and the composition of growth is now slightly less favourable for Canada.”

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In response, the Bank removed the language from its rate-setting statement that suggested that interest rate hikes weren’t far away. The new position is one of neutrality – the next rate  move could be up or down depending on how the economy performs.

The Bank also scaled back its growth projection for 2014 to 2.3% from 2.7% previously, citing “uncertain global and domestic economic conditions (which) are delaying the pick-up in exports and business investment.” As a result, the level of economic activity is “lower than the Bank had been expecting”.

Growth will pick up. However, the expansion won’t be anywhere near as robust as had once been hoped. Unemployment rates should start to fall, albeit modestly, and capital spending will increase. Among the beneficial side effects will be more government revenue, thus cutting the deficit faster. A recent report said that so far this year, Ottawa is about $7 billion ahead of its deficit forecast. The U.S. is in a similar position, in proportionate terms.

Stronger growth will put upward pressure on interest rates. While the Bank of Canada and the Federal Reserve Board will likely continue to keep their target rates at current levels, the effects will be felt in the bond market where government and corporate issues trade. We already had a taste of this when commercial rates jumped in May in response to speculation that the Fed would soon begin to wind down its quantitative easing program. If there’s a repeat in 2014, we may see more downward pressure on REITs, preferred shares, etc.

Returns from Toronto and New York will converge. There has been a huge disparity in the returns from the Toronto and New York stock exchanges this year. The TSX has struggled to post a single-digit advance while all the major U.S. indexes are well into double-digit territory.

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I have been saying for several years that New York was a better place for your money than Toronto. But that could change in 2014. Wall Street might still outperform us but I think the gap will be much less and may disappear entirely.

There are two reasons for this view. First, the U.S. market is coming off a big year. Historically, advances of this magnitude have been followed by a year of consolidation. Second, Canadian stocks for the most part have not experienced the price increases we have seen in the U.S. so there is more room to move higher. Resource stocks, especially, are unlikely to have as terrible a year as in 2013. As long as the global recovery gathers steam, even at a slow pace, commodities prices should gradually firm. My expectation is then both Toronto and New York will post low double-digit gains next year.

Gold should do better. Bullion had terrible year in 2013 and is down about 20% year-to-date. The miners fared even worse. I expect demand for gold to pick up in 2014 as accelerating growth starts to push up the inflation numbers. But the gains could be modest and a recovery to the US$1,600 range, where bullion sat at the start of this year, seems unlikely. Gold should be held mainly as a defence against renewed inflation and currency devaluation.

The bottom line is that equities are the place to be in 2014, especially those with a growth orientation. Bonds and interest-sensitive securities will continue to be under pressure and defensive positions are recommended.