Four times a year, we make a 180-day forecast for the economy and stocks. We pick 25 stocks we expect to beat the market over that period and 25 stocks we expect to lag behind. But remember, stock markets rarely behave like they’re expected to. In fact, the market seems to take delight in confounding investment forecasts.
In 2017, Canada’s GDP is expected to advance by 2.2 per cent. (GDP, or Gross Domestic Product, is the value of the goods and services produced in a country over one year.) This would beat last year’s growth by a full percentage point. The United States’ GDP is also expected to grow by 2.2 per cent this year. If so, the two North American economies will lead the G7 (Group of Seven industrial countries).
Canada and the U.S. are doing better
Faster GDP growth means the Bank of Canada need not cut interest rates. In fact, the central bank is likely to eventually raise rates. That’s why the loonie may recover somewhat against the U.S. dollar. This could trim your returns from American investments.
In May, Canadian employers created a net 55,000 jobs. Even better, more full-time jobs overcame fewer part-time jobs. In the year to May 31, Canada gained 317,000 jobs. While the unemployment rate rose marginally, to 6.6 per cent, that’s because more Canadians feel it’s now worth looking for work.
In the short run, the outlooks for the economy and the stock market are favourable. But there are risks. One is the ‘re-negotiation’ of NAFTA (North American Free Trade Agreement). A second risk is that embattled US president Donald Trump may fail to persuade Congress to enact his expensive economic plans. This could lead the market to give up at least some of the gains that it made after president Trump’s triumph. A third risk is that rising interest rates will hurt the economy and asset prices.
Interest rates are expected to rise quickly in the U.S. In fact, the U.S. central bank is expected to raise interest rates at least three times in 2017. This is likely to raise interest rates on this side of the border.
Rising interest rates would hurt over-indebted Canadian consumers. One reason house prices soared was because record-low interest rates made big mortgages affordable. Rising interest rates will makes big mortgages less and less affordable. At that point we would expect house prices to decline—especially in Toronto and Vancouver. Less construction would slow Canada’s economy.
When bonds yielded next to nothing, many investors shifted money from maturing bonds into stocks. As interest rates rise, some money will go back into bonds. This could limit stock gains.
Flat or lower house prices and flat or lower stock prices could lead to a negative ‘wealth effect’. That is, consumers who suddenly feel no better off or poorer would be likely to cut back on their spending. This would knock off an engine of the economy.
It’s possible the U.S. central bank will resume raising interest rates slowly. Higher rates attract money worldwide. These inflows drive up the dollar. This would make U.S. exports more costly and reduce the value of companies’ overseas earnings.
Canada’s net exports have added to its economic growth. But a big border tax would hurt Canadian exports. This is compounded by less export capacity than before the financial crisis and recession of 2008 and 2009. A lower loonie would assist exports, but may not fully compensate for a re-negotiation of NAFTA. This engine is at risk. One way to reduce this risk is to hold more American stocks.
Company investment has recovered somewhat. This engine would assist the Canadian economy. Trouble is, companies are unlikely to invest until uncertainty over NAFTA is cleared up. Even foreign companies will hesitate before investing in operations to serve the whole North American economy.
Government spending is likely to rise
One engine that should strengthen in Canada is government spending. The federal government, for example, plans to invest substantial amounts in infrastructure. This will partially offset potential setbacks in other parts of the Canadian economy.
The current ‘bull’ market is now 99 months old. That makes it the second-longest bull market in the post-World-War-II era. At some point, it will end. If you accumulate cash, you will have an opportunity to buy stocks on the cheap when that next inevitable ‘bear’ market comes along.
Rising interest rates could hurt the stock market. Even so, you should at least keep your stocks. For one thing, many dividend stocks yield more than bonds. For another, growing dividends become more lucrative over time. Interest rates don’t. Also, dividends face less tax than interest income.
In the long run, it’s the direction and magnitude of company earnings that set stock prices. Company earnings are likely on the mend. Some are sitting on piles of cash. If they can’t invest the money profitably, these companies should use it to reward you.
Big overseas markets now matter more
There are other risks that could hurt Canadian stocks. One is a fall in prices for US and overseas stocks. Some stock market setbacks in North America were precipitated by setbacks elsewhere, especially China.
A second risk is companies’ slow sales growth. While many companies earned more in recent years, part of these earnings came from cost cutting—not from higher sales. Without better sales, it’s hard for companies to raise their earnings sustainably.
Unforeseeable risks exist—the ‘known unknowns’ and ‘unknown unknowns’. That’s why it pays to diversify, of course: unexpected events will have less impact on your overall portfolio. Wait for a risk-free time to invest and you’ll always be earning little in cash instead of putting that cash to work.
Remember to diversify across the five economic sectors: utilities, finance, consumer goods and services, resources and manufacturing. Also remember to diversify within each economic sector. (You will find our specific stock selections—25 market-beaters and 25 market-laggards—in the June 23, 2017 issue of The Investment Reporter.)
Accumulate cash. To the extent that you invest, do so gradually. That way, you can profit from dollar-cost averaging (buying your stocks at below-average prices).
This is an edited version of an article that was originally published for subscribers in the June 23, 2017, 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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