Each quarter, we make a 180-day forecast of what we expect the economy and the stock market to do over the next six months.
Here’s our forecast of what we expect of the economy and stock market over the next six months. Just remember to put little faith into short-term stock market predictions, including ours. Billionaire Warren Buffett has joked that stock-market forecasters exist to make fortune tellers look good.
Stock markets in Canada and the US have set many record highs. Very low interest rates make stocks better than bonds. The 1.18 per cent yield on 10-year Government of Canada bonds falls far short of the inflation rate of 3.7 per cent. Many high-quality blue chip stocks pay dividends that yield more. Add share price gains over the past 18 months and stock-market returns beat inflation.
Interest rates remain very low. In addition, many Canadians accumulated a lot of cash during the pandemic. This was partly thanks to government financial supports. There were fewer opportunities to spend cash. And people working at home reduced their transportation costs and the need to buy lunch and lattes.
We now see more risks
We now see more risks. The economy has weakened. In the second quarter of 2021, Canada’s GDP shrank at a yearly rate of 1.1 per cent. (Gross Domestic Product is the yearly value of all goods and services produced.) A shrinking economy can hurt company profits and share prices. In the long run, it’s the direction and magnitude of profits that set stock prices.
Job creation in North America has hit a rough patch. In the latest report by Statistics Canada, the number of jobs slipped. While the US created jobs, it was far fewer than expected. But then, companies need more workers. When government supports expire, many people are likely to find work. And paychecks have increased.
As long as supply chains are disrupted, Canada’s economy is likely to suffer. Consider, for instance, vehicle exports. Due to a shortage of computer chips, Canadian auto-parts and vehicle manufacturers have had to cut their production. This reduces exports, which slows economic growth.
‘Buy America’ policies could further reduce exports to the US. Still, President Biden’s US$1 trillion infrastructure renewal bill will assist Canadian engineering companies, such as Stantec Inc., ADF Group, Aecon Group, ATS Automation Tooling Systems, Bird Construction, SNC-Lavalin Group and WSP Global Inc. All are buys. What’s more, President Biden cited forest fires in the West, drought on the Prairies and a hurricane that hit Louisiana, New Jersey, New York and Pennsylvania as evidence that climate change is here. Congress may pass another US$3.5 trillion on newer disaster-resistant infrastructure, despite some opposition.
The Delta Variant of COVID-19 is infecting millions upon millions of Americans. And with more people going inside as the weather gets colder, the situation is likely to get worse. Too few Americans have taken advantage of free vaccines. This has created what’s known as a ‘pandemic of the unvaccinated’. This could lead to lockdowns of the economy. This would likely significantly reduce demand in the US and Canada. It’s often said that ‘when the US sneezes, Canada catches a cold’.
Even if the economy grows, the stock market could suffer a setback. In 1987, the American economy was humming along. On October 19, however, the Dow Jones Industrial Average crashed and lost over a fifth of its value in just one day. Even so, buy-and-hold investors went unscathed. An investor who bought a Dow index fund on New Year’s Day, 1987, was up a little by New Year’s Eve.
Many governments in the developed world have spent heavily to support their workers and companies. This has led to enormous budget deficits. At some point, governments will have to tighten their fiscal policies and wean their economies off life-support payments.
Another ‘Taper Tantrum’?
Some governments have run loose monetary policies. In order to keep interest rates low, many central banks bought up fixed-income investments. This ‘quantitative easing’ greatly increased central banks’ holdings. Now some, including the Bank of Canada, have reduced their purchases of new fixed-income investments. Eventually, central banks will sell their holdings, particularly if inflation remains a problem. This could create another ‘Taper Tantrum’ similar to the one that occurred when the Federal Reserve first tried to taper its holdings of fixed-income investments.
Another risk is seasonality. September is the one month in which stock prices dip, on average. October is a positive month for the stock market, on average. But most of the stock market’s worst crashes have occurred in October.
At some point, the market will suffer its next setback. But nobody knows just when this will happen. Continue to gradually nibble at high-quality, dividend-paying stocks. Also conserve some cash to make the most of that next stock market setback.
This is an edited version of an article that was originally published for subscribers in the September 17, 2021, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.
The Investment Reporter, MPL Communications Inc.
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