Canada in 2010

At the recent World Money Show in Toronto, I was asked to deliver a keynote presentation on the topic: What Lies Ahead? The Canadian Market in 2010.

As I told the audience, making predictions in this uncertain and volatile climate is something akin to sky diving. You pray the parachute will open, otherwise the landing will be mighty uncomfortable. With that disclaimer, here are some of the key points I made during my talk.

For starters, it’s important to put things into context. We have just come through perhaps the most traumatic 12 months that most investors have ever experienced. (The exceptions are those old enough to remember 1929-30.) A year ago at this time, we were facing what looked like financial Armageddon. The world banking system was crumbling, credit had seized up and talk of a 21st century Great Depression was everywhere.

People were bailing out of the stock market for the safety of cash and government bonds and many remain on the sidelines to this day, fearful of being whipsawed again. Their nervousness is exacerbated by doom-and-gloom pundits who flit about like Halloween goblins, warning of more catastrophes to come.

Thus far, the markets have chosen to ignore the fear mongers, last week’s pull-back notwithstanding. As of the time of writing, the S&P/TSX Composite Index was showing a year-to-date gain of 27.1 per cent. If stock markets are truly leading indicators (and there is some debate on that score) then 2010 should turn out just fine.

That’s not to say there aren’t more hurdles to overcome. Here in Canada, the loonie continues to worry our central bankers, we’re facing years of budget deficits and spending cuts, the country is experiencing trade deficits for the first time in years, unemployment remains stubbornly high and the spreading swine flu virus may affect fourth-quarter GDP.

In the U.S., the housing market still has not recovered and foreclosures remain high. The banking system still looks fragile, runaway government deficits make our politicians look like fiscal geniuses, there are concerns the commercial real estate market will implode, and on and on.

A wall of worry? How about a mountain?

Still, I happen to be a glass-is-half-full type of person. I look at our solid banking system, now held up as an example for the world, and thank heaven for our innate caution when it comes to our basic institutions. I look at our abundant resource wealth and marvel at our good fortune to live in such a richly-endowed land. I give thanks that our politicians, with all their faults, had the good sense to run more than a decade of surpluses, storing up credits for the rainy day that finally came.

It all adds up to cautious optimism when I look at the year ahead. There will be surprises, of course, both good and bad. But this is what I expect to happen based on current trends.

1. The loonie will remain strong. I can see no reason why the loonie will drop significantly in value next year, unless we experience a world double-dip recession, which I do not expect. Whether we like it our not, our dollar has become something of a petro-currency and if oil prices continue to trend higher, which I think they will, that will provide further upward pressure on the loonie. I would not be surprised to see us at parity with the U.S. dollar or perhaps slightly higher for most of the year. I do not believe the Bank of Canada has the tools to prevent that; the best it can do is slow the rate of the increase.

2. Inflation will resurface. Right now we are experiencing a period of deflation in this country but I do not expect that to continue. The Bank of Canada is predicting a “modest recovery” that will result in an increase of 3 per cent in GDP next year and 3.3 per cent in 2011. Assuming that is anywhere near accurate, we should see companies gradually rebuilding inventories in the next few months, leading to a pick-up in overall economic activity. Deflation should give way to a gradual rise in inflation early next year, moving towards the bank’s target rate of 2 per cent by year-end.

3. Interest rates will rise. Bank of Canada Governor Mark Carney has repeatedly reaffirmed the commitment to hold the key overnight rate at a record low 0.25 per cent until the end of June 2010. I expect that he’ll stick to that, however, shortly thereafter rates will start to move up. Bond prices will weaken in advance, with government issues the most vulnerable. Bond investors reaped big profits during the recession but those days are just about over. For GIC investors, the message is: stay short. GIC yields will start to rise next year and you don’t want to be locked in for the long term when they do.

4. Gold will remain strong. I have never been a gold bug but it is difficult to see any significant drop in the price of bullion in the face of a weakening U.S. dollar and increasing talk of replacing it as the world’s reserve currency. Coincidentally, one of the other keynote speakers at the Money Show was Ian McAvity, one of Canada’s leading experts on gold. We independently arrived at exactly the same target price for gold in 2010: US$1,200. That may turn out to be conservative considering bullion shot past US$1,100 in early November and gave no signs of slowing its pace.

5. Market growth will slow. We are unlikely to see a repetition in 2010 of the explosive stock market rebound we have experienced since March. There is still money to be made but the low-hanging fruit has been picked and investors will need to be more selective. We could see some earnings disappointments as the strong loonie cuts into corporate profits, as happened when we went past parity in 2007. For example, Canadian Pacific reported an after-tax foreign exchange loss of $18 million on long-term debt when it released its third-quarter results last week.

At this stage, my view is that the TSX will post gains in the low double-digit range (10 per cent – 12 per cent) in 2010, ending the year in the 12,000 to 12,200 range. However, there will be a lot of volatility along the way so you will have to have a strong stomach at times.

Adapted from an article that originally appeared in Gordon Pape’s weekly newsletter, the Internet Wealth Builder. Try it for one month (4 issues) for only $13.95 plus tax. Details here.

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