Thanks to the massive stimulus unleashed by the Federal Reserve’s QE3 program, and similar aggressive stances at other central banks around the world, signs are mounting that the world economy is headed toward a synchronized boom. All of which suggests 2014 will be a good year for Canada. Look for the economy to gain more momentum, the housing sector to again defy the skeptics, and the Toronto Stock Exchange to continue climbing.
For portents of an acceleration in global growth, consider a key leading economic indicator, the Purchasing Managers’ Index for manufacturing. As data from the Organization for Economic Co-operation and Development show, the PMIs for Japan and Europe recently broke above the 50 level, the threshold above which manufacturing sectors head into expansion. PMIs for China and the U.S. continue to move further above their 50 levels.
Another leading indicator for the global economy is the Baltic Dry Index, a measure of the cost of shipping by sea various bulk goods (mainly raw materials). After hovering near the 1,000 mark for most of 2013, it has doubled in the past three months to 2,000.
Of particular relevance to Canada is ongoing growth in U.S. jobs. A better-than-expected 203,000 persons were added to U.S. payrolls in November, extending the upward surge of recent months (and bringing unemployment down a bit more, to a five-year low of 7%). Gluskin Sheff economist David Rosenberg called the latest numbers “the strongest jobs report this cycle.”
Rising employment and incomes around the world generate greater demand for Canadian goods and services. Furthermore, as the U.S. revs up, its currency strengthens against the Canadian dollar, enhancing the purchasing power of U.S. consumers. As Canadian exporters respond to higher demand from the U.S. and other countries, they will spend more on new equipment, expanding plant capacity and hiring people, delivering a stimulus to the rest of the economy.
Growth in domestic incomes and jobs will be supportive of the Canadian housing sector and substantially moderates the risk of a sharp downward adjustment. In a sense, Canadians have been fortunate to have their housing “bubble” come along when the world economy is recovering. If Canadian policymakers continue to use this period to restrain house price increases (with mortgage restrictions and other regulatory changes) while the fundamentals improve, a painful denouement can perhaps be avoided.
A ramping up of the global economy in 2014 should breathe more life into economically sensitive companies, mostly in the housing, automobile, financial, technological, transportation and basic-materials sectors. Since the TSX has a relatively large allocation to such cyclical companies, it could play catch up to the stellar performance of the U.S. stock market over the past two years. There have already been run-ups to some of the cyclicals, particularly housing-related sectors such as mortgage insurers and lumber companies—but deep cyclicals, notably the basic-materials group, remain depressed and could now be contrarian buys.
One caveat is that investor sentiment has become very bullish in the stock market. As well, there is a risk U.S. economic growth could speed up too fast, causing bond yields to jump; even short-term policy rates could tick up if the Fed feels it needs to reassure the bond market that the economy will not overshoot and exceed inflation targets. Although the broad trend in the stock market should be upward, there will likely be corrections and greater volatility along the way.
As always, anticipated scenarios (such as the above) are subject to the whims of Black Swans lurking in the shadows. Should territorial disputes between China and its neighbours lead to military conflicts, for example, the world economy would be in uncharted waters.
Larry MacDonald is a former economist who manages his own portfolio and writes on investment topics. He is the author of several business books