The world economic recovery continues to unfold. After the most synchronized global contraction on record, world output turned the corner in mid-2009 and has rebounded strongly since then. There is considerable momentum heading into 2011. However, the overall picture masks a two-speed world economy – with emerging markets in the fast lane and the developed world lagging.
|Rates of Return||1 Month||6 Month||1 Year|
|S&P/TSX Composite Index||3.79%||19.03%||14.45%|
|S&P 500 Index||6.53%||22.02%||12.78%|
|5 year Canada bonds – benchmark yield as of December 31, 2010 is 2.46%|
2011: The Year Ahead
Interest Rates Lower for Longer
While interest rates have begun to creep up since the initiation of the U.S. Federal Reserve’s Quantitative Easing 2 (“QE2”), we expect rates to remain relatively low. While this is good news for equities as rates will not be seen as threatening, it is bad news for income-oriented investors in search of yield. The Fed in particular, and other governments world-wide, will continue with very accommodative monetary policies in order to sustain the weak economic recovery. The implication is that bond yields will only edge up slightly in the coming year, and that should be good news for Canadian equities. Moreover, although economic growth will be modest, corporate profits are projected to rise roughly 7% in 2011 on both rising domestic earnings but also reflecting the rally of commodity prices since their recession lows, all of which is constructive for Canadian stocks.
This suggests that inflation should not be a problem in Canada, and that means the Bank of Canada (BoC) does not have to be in a rush to raise interest rates. The BoC may still elect to raise rates in 2011, as it is concerned about leaving rates too low for too long and it has voiced some concerns over growth in household indebtedness. While Canadian economic growth will trail that of the U.S. in 2011, this masks the fact that the Canadian economy has far less slack – as illustrated by the lower unemployment rate in Canada. TD Economics does not expect the BoC to resume raising rates until the second half of 2011, and we can only expect the overnight rate to rise by 1 percentage point by the end of the year.
The Global Economy
We are optimistic that 2011 will continue a slow, modest economic recovery. In the U.S., corporations are in great shape; the housing crisis may be troughing; job growth should continue to creep upward and the consumer is gradually deleveraging – nothing too exciting but still an upward trend. We see better prospects for growth in emerging market economies which have better balance sheets and fundamentals. China remains the key; with the People’s Bank of China raising bank reserve requirements and possibly interest rates to contain inflation. There is a concern that they will inadvertently engineer a hard landing, which could hurt global growth. As for Canada, because our economy is so closely linked to the U.S., it will likely follow the U.S. economy closely. Our resource-based industries will do well should developing economies continue their strong growth.
The Canadian economy is expected to grow at 2.7% in 2011, just slightly trailing the performance in the United States. While Canada does not face the same challenges as the U.S. the gradual growth in the U.S. economy will act as a constraint on prospects for Canadian exports. Canadian exports will also be hampered by a Canadian dollar that will average par, or better, against the U.S. dollar in the coming year. On the domestic side of the economy, Canada’s real estate markets have come in for a soft-landing, with prices relatively flat in year-over-year terms heading into 2011. This means that housing activity will not be a boost to economic growth in the coming year, and retail spending on housing-related items, like furniture and appliances, will not be strong.
While the outlook is for a continued world economic recovery, it is important to stress that volatility may remain a challenge for investors. The economic prospects suggest that that the fiscal problems in Europe will take a long time to be addressed and debt restructurings cannot be ruled out. Moreover, it seems only a matter of time before the U.S. fiscal deficit will become a greater concern. Many other global imbalances will also persist. The bottom line is that the world recovery is proceeding, but it is happening in the context of uncertainty and many risks. This is a recipe for continued financial volatility.
Should you have any questions, please do not hesitate to call.
Ken W. Wilk
Portfolio Manager and Investment Advisor
T (204) 988-5221 F (204) 988-5236 Toll free 1-866-988-5221
* Comments summarized from 1) TD Waterhouse Monthly Perspectives December 2010 and 2) Private Investment Advice Wealth & Wisdom Winter 2011
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