Global outlook 2013: Finding success in a risky market

With European uncertainty, slower growth in China
and budgetary wrangling in the U.S., 2013 will be
a tough year. But there are still opportunities for
savvy investors

1

The all new Investor’s Guide 2013 is your complete compendium to make the coming year a profitable one in these turbulent times. The 130 page guide includes the best stocks to buy right now, a step-by-step guide to picking winners, the hottest international markets and Canada’s most profitable companies.

The Investor’s Guide 2013 is available on newsstands or by ordering here.

Our Global Outlook for 2013 begins below,

Sam Javanrouh

It’s becoming harder and harder to remember just how
good Canada had it before the recession. Between 1996
and 2001, our gross domestic product grew, in real terms,
by 23%. Between 2001 and 2006, it expanded by 14%.
Our stock market climbed about 160% during the same
10-year period. The federal budget was in surplus, our
personal debt was manageable and housing costs weren’t
out of control. In other words, our economy was booming
and our wealth was growing. That all changed in
2008, when the S&P/TSX composite index plummeted
nearly 25% in one week. In the four years since, our GDP has
grown about 3.5%. While our stock market is closer to its prerecession
highs—it’s up about 14% since October 2008—it’s down
nearly 8% over the past two years.

Most economists agree that the 5% annual growth we saw in
the late 1990s is behind us—for good. It’s true that Canada weathered
the recession better than the other G7 countries, and we’re
still in relatively good shape; but in this increasingly global environment,
our economy can’t improve until other nations—namely
Europe, China and especially the U.S.—see their own financial
fortunes rebound.

When these countries will start seeing meaningful growth
again is anyone’s guess, but it’s now safe to assume that the
global recovery won’t pick up speed any time soon. In October,
the International Monetary Fund downgraded its global growth
projections for this year and next. It now expects the world’s
economy to expand by 3.3% in 2012 and 3.6% in 2013, down
from its July estimate of 3.5% and 3.9%, respectively. That is
getting closer to the near 4% growth the planet experienced
during the mid-2000s, but David Madani, a Toronto-based economist
with Capital Economics, thinks those projections are way
too bullish. People “are too optimistic regarding the prospects
of global economic growth,” he says. “We still see a lot of downside,
including oil prices falling and a lot of political risks.”
David Rosenberg, chief economist and strategist at investment
firm Gluskin Sheff & Associates, agrees. “There is still more
downside risk to the outlook than upside potential,” he says.
“The world is still fragile.”

THE EUROPEAN THREAT

Europe continues to be the biggest threat to the global economy.
Depending on whom you ask, the crisis will either worsen or
plod along; hardly anyone says it’ll get much better next year.
Rosenberg is particularly worried about the region. While European
leaders are focused on finding financial fixes for Spain,
Italy and Greece, he says things won’t improve until people
start dealing with France. “Europe will face its existential moment
once this hits France,” he says. “It has huge structural flaws
and a destabilizing budgetary imbalance. It’s the one country
Germany won’t be able to bail out.”

Craig Alexander, TD Bank’s senior vice-president and chief
economist, says that while things are bad, they likely won’t get
much worse. There won’t be a sudden resolution to the crisis,
but he thinks Europe is moving more toward banking and fiscal
unity. There is one catch: the whole process could get derailed
if the masses get fed up with all the dramatic spending cuts. In
order to receive aid money from the International Monetary Fund and the European Union, troubled countries are being
forced to implement drastic austerity measures, which are supposed
to help get their books back into shape. That will likely
lead to severe economic contraction, high unemployment and
a lot of angry citizens. We’ve already seen riots in Greece. It’s
highly possible violence could break out in other countries too.
If that happens, governments may decide to pull the plug on
austerity. “Each time you encounter a backlash, it starts to raise
the possibility that the government will change their position,”
he says. Unfortunately, “reality is setting in that some of these
commitments are too extreme,” he explains. He’s optimistic that
aid packages will be modified and struggling nations will find
some manageable balance between austerity and growth. But,
he admits, the political situation is so tenuous that’s it’s impossible
to make any steadfast predictions. “There’s such a big political
risk,” he says. “So you don’t know how things will play out.”

Fortunately, Canada is less directly affected by Europe’s
fortunes than others. We don’t trade directly with the region
much—only 9.6% of our exports
go to western European countries—
and our financial institutions
have almost no exposure
to European sovereign
debt. The real risk is if, thanks
to country defaults, the continent’s
banking system collapses.
The world’s investors
would likely panic and pull
money out of equities, the
banks in particular. Even
though our institutions are in
good shape, they’ll suffer. “It’s
a case of throwing the baby
out with the bathwater,” says
Rosenberg. Most economists
think European GDP growth
will be f lat next year, if not
slightly negative, and it will
continue to muddle through
its issues. That’s perfectly fi ne
for Canada. As long as things
don’t get worse, our economy
shouldn’t get dragged down
by Europe any more than it
already has.

CHINA’S SLOWDOWN

While a European collapse may be the biggest risk to the global
economy, another significant issue is a continued emerging market
slowdown—especially in China. Between 2007 and 2011,
China’s annualized growth rate was 9.3%; the IMF predicts 2012
GDP growth to fall to 7.8% and rise slightly to 8.2% in 2013.
That’s still rapid growth—far better than any developed nation—
but because it’s such an integral part of the world’s importing
and exporting ecosystem, even the slightest economic pullback
will have some eff ect on the rest of the world.

Part of the reason for the slower growth, says Avery Shenfeld,
CIBC World Markets’ chief economist, is that cash-strapped
Europeans and Americans are buying fewer goods from China.
In September, HSBC reported that its China Manufacturing
Purchasing Managers Index—an economic indicator that speaks
to the health of the manufacturing sector—was a low 47.9. It’s
been below 50, meaning manufacturing has been contracting
nearly every month since June 2011.

The government was also forced to fight rising inflation last
year by withdrawing post-recession stimulus measures. That’s
affected real estate prices and construction activity. The worst case
scenario is that the country will experience what economists
call a “hard landing,” essentially a major slowdown in
GDP growth, to less than 5% or the approximate rate of inflation.
But because the government has so much control over the
country—control no developed nation or most other emerging
markets have—Shenfeld thinks that any hard landing will be
short-lived. It’s more likely the country will continue to slow,
but only slightly. The CIBC economist expects the country’s
GDP to grow by about 7.5% in 2013.

Many experts think Chinese officials will actually renew stimulus
measures to get the economy moving again. It could do that
through infrastructure spending, but it may also cut interest rates.
The country has already lowered rates—the one-year lending rate
is at 6%, down from about 6.5% in June—but, says Alexander, it
could reduce that further to help spur growth. However, he does
point out that the Chinese authorities would likely prefer to alter
bank reserves and lending directives,
and add fiscal stimulus,
before slashing rates. Because
China can do pretty much whatever
it needs to increase economic
activity, Rosenberg says,
“it’s the part of the world that
will come back first.”

Canada doesn’t do enough
business with China to be
affected by a slowdown on a
trade-related basis—only 3.8%
of our exports make their way
directly to the Communist country.
However, slower growth can
hit us where we’re most vulnerable—
in commodity prices. The
country is a huge importer of resources like oil, copper and iron
ore, and when demand for these products decreases, it affects
global prices. Thanks to a slowdown in China and other emerging
markets, but also because of a sluggish U.S. economy and
political risks in the Middle East, Madani thinks oil prices could
fall to $75 a barrel next year. But his view is more bearish than
others’. Warren Jestin, Scotiabank’s senior vice-president and
chief economist, thinks China is still growing fast enough to keep
oil between $95 and $105 per barrel. Beyond 2013, prices could
climb further as the country’s domestic growth continues. “Most
of the net demand globally for commodities will be generated
from the emerging world,” he says. “Now there are new consumers
who didn’t consume oil and steel before.” As long as there is
growth, he says, the commodity sector should remain strong.

Alexander takes a more middle-of-the-road view on commodity
prices. He points out that the double-digit growth much of
the emerging market experienced in 2010 is over, so it’s unlikely
we’ll see oil prices rise, at least in the short term. However,
continued demand from developing nations should keep prices
stable. We might see a bit of a setback due to leisurely global
growth, but the “downside will be limited by improvements to
conditions in the emerging markets,” he says.

Rosenberg doesn’t want to make a projection for oil, but, he
says, commodity prices are 75% correlated with the Chinese
stock market. When the Shanghai composite index rebounds—
it’s down about 16% over the past 12 months—and signals that
the worst of the slowdown is over, commodity prices “will be
on more of a decisive upward trend.”

UNITED STATES STILL SLUGGISH

The country that affects Canada’s fortunes the most is, naturally,
the United States. According to Export Development Canada,
about 74% of our trade is with that country. Two-thirds of
our commodities and more than half our non-commodity exports
end up in America. “It’s still true that where the U.S. economy
goes, so too does Canada,” says Alexander. Fortunately, things
are looking up below the 49th parallel. About 14 million automobiles
will drive off dealer lots this year, up 40% since the
2009 low, yet there’s still room to grow; sales topped 17 million
before the recession. U.S. housing starts are also recovering,
up 56% from the April 2009 trough. In July, the S&P/Case-Shiller
U.S. National Home Price Index increased 1.2% year-over-year,
the biggest 12-month gain since August 2010.

Job data also appear to be improving. America’s unemployment
rate fell to 7.8% in September, while Gallup’s U.S. Job Creation
Index—which looks at the country’s net job creation—is
up 263% since it bottomed out in April 2009. Sherry Cooper,
executive vice-president and chief economist at BMO Financial,
says there’s an enormous amount of pent-up demand in the
U.S. After four years of economic uncertainty, consumers and
businesses are itching to spend again.

Thanks to these improving fundamentals, Cooper estimates
that the country will grow at about 2.3% next year, slightly
higher than the 2% growth she expects this year. The IMF has
a similar prediction, for 2.1% GDP growth in 2013. However,
that number is threatened by a possible event: the U.S. fiscal
cliff . The cliff is the default outcome of the Budget Control Act
of 2011, a federal statute that helped bring the U.S. debt-ceiling
crisis to an end. To reach that compromise, lawmakers agreed
that, on midnight of Dec. 31, a series of tax increases and spending
cuts would automatically take effect. A report by the Congressional
Budget Office says the fiscal cliff could devastate the
U.S. economy. It would reduce economic growth from 4.4% to
negative 0.5%. Two million more Americans would find themselves
out of a job. The Tax Policy Centre says taxes would
increase by $500 billion, or $3,500 per U.S. household, while
$110 billion will be slashed from government budgets.

If the fiscal cliff ’s cuts are allowed to stand, Alexander says
the U.S. could find itself in another recession. He thinks U.S.
GDP will expand by 2.25%, but if all of these massive tax increases
and spending cuts happen, then GDP will contract by about
1%. However, he and most other economists think Republicans
and Democrats will come to some sort of compromise before
the end of the year. “Everyone knows the impact of this,” he
says. “If you know something will happen that will cause a
recession, then you’ll do something to avoid that outcome.”

Madani agrees. He thinks the fiscal cliff issues will be avoided
at the last minute. But even so, he thinks GDP will only grow
by about 1.5%—lower than most estimates. Even with increasing
employment numbers, not enough people are getting back
into the job market to spur economic growth. He also warns people to not read too much into the housing data. The real
estate situation was so poor, he says, that it had to move upward
at some point: “I wouldn’t get too excited about that.” Rosenberg
is also cautious on the U.S. While some economic indicators
are improving, others are still depressed. “In any given
moment, some things are doing well while other aren’t doing
so well,” he says. He points out that while the 12-month home
sales chart looks impressive, the housing picture isn’t as rosy
if you look back at the past half-century. In that case, housing
starts are still well below the 50-year average.

Still, the U.S. is moving in the right direction. It’s just not moving
fast enough. “It’s growing, but it’s too slow to get the U.S.
out of its fiscal problems and too slow to get business to aggressively
expand investments and create jobs,” says Jestin. The
Federal Reserve hopes its quantitative easing program, which
now appears to be open ended, will help stimulate the economy
further, but the Scotiabank economist thinks its usefulness has
run out. He admits that the economy would be in worse shape
without it but, at this point, it won’t boost growth. “They’re just
trying to sustain growth at a fairly modest rate,” he says.

America’s GDP growth is also too slow to boost Canada’s
fortunes. While our lumber sector may benefit from a recovering
home sector, and growth in car sales is good news for Ontario
manufacturers, Alexander says we won’t see any dramatic
increase in demand for our exports.

CAREFUL, CANADA

What does all of this mean for Canada? Expect another sluggish year of growth. Canada’s big-bank economists all predict about 2% growth for the country next year, which is in line with IMF estimates. However, Cooper says that there are a lot of headwinds facing our economy. In the States, housing is still near all-time lows, the government is encouraging consumer spending and mortgage lending and the U.S trade deficit is improving. It’s the opposite story here. “Canada is in a very different place than the U.S. at this point in the cycle,” she says.

One of the biggest worries is Canada’s overheated housing market. Since 2005, the Multiple Listing Service’s Home Price Index has climbed 55%, while housing prices have jumped about 90% over the past decade. Our personal debt-to-income ratio is at its highest—153%—partly due to rising real estate costs. Many experts have said Canada’s housing market could experience a U.S.-style crash. Cracks are appearing in the real estate market already. Home sales fell 5.8% in August from the month before, and were down 8.9% year-over-year. In Vancouver, home to the country’s most expensive real estate, residential property sales fell by a third in September, compared to a year earlier.

Madani is bearish on Canada’s economy. He thinks it’ll grow by just 1.2%, mainly because the housing market is going to get worse. “The trend will continue and, down the road, we’ll see some outright declines in housing prices,” he says, in the order of 25%. If that happens, we’ll see our unemployment rate rise to 8% from about 7.3% today at the end of next year.

TD’s Alexander also thinks housing starts will slow next year and in 2014, which will affect the construction industry and weigh on our economic growth. He points out that the resale market doesn’t have much of an impact on GDP numbers, but slower home sales could affect consumer spending. About 20% of retail sales are on furniture and appliances, he explains. If the housing market drops or moves sideways—he thinks it’ll be the latter—it will slow down spending. Fortunately, the Canadian government has taken steps to reduce the likelihood of a major housing crash. In early July, it reduced amortization periods on government-insured mortgages to 25 years from 30 years. The real estate declines we’ve seen since then are likely due to these new rules, says Alexander.

Some people, including Bank of Canada governor Mark Carney, are concerned about our personal debts. An August Trans- Union report revealed that Canadians hold, on average, $26,221 in non-mortgage debt, the highest debt levels the credit-rating firm has ever recorded. Carney has said that high consumer debt is the biggest risk facing Canada today. Alexander believes that our debt levels are too high, but not enough to bring down the economy. It just means consumer spending will expand by about 2% in 2013, slightly lower than this year. Madani adds that due to our total debt levels, including housing, banks may be more reluctant to loan money to consumers. Cooper also thinks that consumer spending will slow, but not because of our debt—she doesn’t think Canadian households are overextended— but because there’s no pent-up demand for goods.

While domestic issues are weighing on our growth, the usually bearish Rosenberg says that Canada’s actually in great shape compared to everyone else. We’re not facing a fiscal cliff; we’re not dealing with defaults and retrenchment like Europe; our banks are solid, and he’s not worried about our housing market. “Economic growth will be sluggish, but there’s far less downside risk here than anywhere else,” he says.

He’s satisfied with the measures the Bank of Canada has taken to stabilize our economy over the years and says our growth is being “promoted and nurtured” by our strong Canadian dollar. While exporters will continue to struggle, most Canadian businesses can actually become more profitable from a position of parity. “Canadians can buy technology inputs from the U.S. at prices we could have only dreamed of about 10 years ago,” he says.

Shenfeld thinks the loonie will stay around par, but could get as high as US$1.04 in 2013, thanks to continuing demand for Canadian-dollar bonds from foreign countries. He cautions that when looking at our currency’s value in relation to our underlying trade fundamentals, the loonie looks overvalued. The IMF says the dollar is about 10% overvalued compared to our trading partners. That’s also in line with what Madani thinks. He predicts that because of lower energy prices, our dollar will fall to around $0.90 next year. But Madani is in the minority. The bank economists say the dollar will fluctuate in the $0.95 to $1.05 range, mainly because of that foreign interest and a strong commodity market. “Commodity strength is directly related to Canadian-dollar strength,” says Jestin.

Interest rates and inflation should also stay low next year. Jestin says that one reason why some people were expecting a rate hike sooner than later was because of our housing market. A rate increase would have helped cool real estate prices, but since the new mortgage rules seem to be doing that, there’s less impetus for a raise. Another reason rates won’t climb, says Cooper, is that an increase will certainly cause the loonie to spike and that would put enormous pressure on exports. She thinks the Bank of Canada won’t increase rates, at least not significantly, until the Federal Reserve does, which it has indicated won’t be until 2015. Alexander agrees that we’ll remain in a low-interest-rate environment for at least two or three years, though he can see the Bank of Canada increasing rates by, at most, 1% between now and 2015.

Inflation won’t be much of an issue in 2013, either. The only threat, says Jestin, is rising agricultural prices, which would make food more expensive. He thinks inflation won’t exceed 2%. It could rise in the years ahead, when countries pull back their stimulus, and the cost of producing goods in China increases, but that’s not a near-term issue. “In the here and now, the global economy is too soft,” he says. If commodity prices soften and the housing market corrects, inflation could fall to 1.2%, says Madani. However, most Canadian bank economists think it will stay around the 2% mark.

Modest as our economic growth will be, people in Western Canada, and especially in Alberta, may feel wealthier than those in Eastern Canada. A booming energy sector means, once again, that Alberta will grow faster than the rest of the country. BMO Economics estimates the province will see 2.9% GDP growth in 2013, while Saskatchewan will expand by 2.7%. It’s a different story in Ontario and Quebec, where provincial governments are reducing spending to get deficits under control. Ontario is also dealing with a housing slowdown and a struggling manufacturing sector. Research In Motion’s problems don’t help either, says Cooper. Meanwhile the Parti Québécois’s election win, says the BMO report, “casts some uncertainty on the fiscal outlook.” BMO estimates that Ontario will see GDP grow by 1.8%, while Quebec will experience a 1.4% expansion.

Unless there’s some major economic shock, or a steep drop in housing prices, it’s likely 2013 will be a repeat of this year, which means investors should expect yet another middling 12 months for the markets. “There’s a battle between deteriorating economic growth prospects and rampant global liquidity,” says Rosenberg. “So we think the markets will be range-bound.” Volatility will continue, and non-cyclical sectors with dividend yield will be the winners again. Alexander concurs. With interest rates so low, stocks are better than bonds, but the Canadian market, he says, should see mid-single-digit returns.

When will our economy get moving again? It could take a few more years. Exports must pick up, and America’s growth needs to take off . “The domestic side has done a lot of heavy lifting,” says Alexander. “Now Canada needs exports and investments to do some work.”

The Investor’s Guide 2013 is available on newsstands or by ordering here.

One comment on “Global outlook 2013: Finding success in a risky market

  1. What is in store for Canada over the coming calendar year is yet to be seen, but predictions from Canadian experts can provide some type of direction in what we can expect. As we know, Canada has been in a fairly strong position since the 2008 global economic crisis began – especially in comparison to other G7 countries. With that said, this doesn’t go without its challenges.

    Reply

Leave a comment

Your email address will not be published. Required fields are marked *