Fearless forecasts for 2008

Making predictions in these uncertain times is something of a fool’s game. The world never unfolds in the way we expect. Even trends that appear to be clearly established at the start of a year can suddenly go into reverse as unforeseen events change the dynamics.

Last year at this time, for example, I thought that U.S. stocks would outperform our resource-heavy S&P/TSX Composite Index in 2007. Nasdaq actually did beat the TSX but by the time the exchange rate differential was factored in, Canada was once again the best place for your money. Well, at least I fess up to my mistakes!

But it’s a new year and I’m a glutton for punishment so here are my fearless predictions for 2008.

The first half will be rough. There’s too much uncertainty in the markets right now for my comfort level. Credit is still very tight and expensive and there are undoubtedly more bombs from the subprime mess still waiting to explode. Year-end financial results, which will begin to come out later this month, may contain some nasty surprises that will rock the stock markets. I would not be surprised to see one or more sharp corrections between now and spring, with major indexes falling 5 per cent to 10 per cent, perhaps even more. Investors will need fortitude and patience to ride it out.

The second half will see a market rally. By the time second-quarter results come out, the full extent of the subprime damage should be known and credit should start to loosen again. Investors hate uncertainty so even if the subprime news is worse than expected, they’ll welcome a clearing of the air. By mid-year, we should also see signs that the U.S. housing market is stabilizing, which will be positive news for the markets. The election of a popular, middle-of-the-road president who pledges to get the country out of Iraq will also help boost confidence. By the time December rolls around, stocks should be enjoying a strong rally.

The TSX will outperform the S&P 500. I don’t expect any of the major North American indexes to generate double-digit gains in 2008. However, the TSX appears to be in a better position to make a run at that level. U.S. markets will be held back by weakness in the financial and housing sectors in the first half of the year. Canadian financial stocks may also come under some pressure but it won’t be anywhere near as bad as the situation south of the border. Our energy and mining stocks should help to keep us in the black, although I expect a lot of volatility in both sectors.

Interest rates will fall. Interest rate trends don’t normally reverse themselves quickly so I expect we’ll see further reductions, at least in the first half of the year. In the U.S., lower rates will be driven by growing worries about the credit crunch and fears of a recession. In the case of the Bank of Canada, weakness in the manufacturing sector and concerns about a higher loonie if the rate spread with the U.S. narrows will tilt the odds towards further easing.

Bonds will continue to rally. Bond markets finally turned around in the final months of 2007. In fact, bonds actually outperformed stocks in the latter part of the year. Lower interest rates and stock market fears will continue to fuel demand for high-quality government issues in the first half of 2008. Look for yields to drop and bond prices to rise. Bonds will outperform equities in the first half of the year but the situation will reverse itself in the second half.

The loonie will stabilize. We could see a modest advance for the loonie in 2008 if oil prices continue to rise but don’t look for a repeat of 2007. A Canadian dollar at US$1.15 just isn’t on. When our buck touched US$1.10 for a brief time last year, politicians hit the panic button and, with the help of remarks from Bank of Canada Governor David Dodge, succeeded in jawboning the loonie back down to below parity. I expect it to trade in a range of US95c to US$1.05 in 2008, ending the year at around US$1.03.

So there! I’ve gone out on some very long limbs. We’ll review these predictions 12 months from now and see how I fared.