Review of 2012 and outlook for 2013

2012 review

The global economy slowed down in 2012. While the U.S. economy slowly emerged from the 2008-2009 Great Recession, public finances in the euro zone deteriorated, dragging the economy to the brink of a new recession. Emerging countries remained the global leaders but their growth lost steam during the year. Overall, global economic growth slowed this year. Against the backdrop of the euro zone crisis, investing opportunities were hard to find for investors.

At the time of writing (mid-December), U.S. politicians and conflicts in the Middle East were in the spotlight. Clearly, the fiscal cliff has the potential to push the U.S. economy into recession, if Congress and President Obama do not come to an agreement by December 31, 2012 on automatic public spending cuts and the expiry of tax cuts implemented by George W. Bush. If no agreement is reached, the U.S. will be plunged down a fiscal cliff of $607 billion, which amounts to a 3.8% decrease in economic growth each fiscal year. Without a political agreement, the fiscal cliff could trigger a sharp deterioration of U.S. and global economic conditions, leading to considerable short-term volatility in capital markets.

“However, while Canada’s economy is being affected by the global angst, the key areas of uncertainty abroad are all points of justifiable confidence here at home,” said Mark Carney, Governor of the Bank of Canada on October 15, 2012. “Canada’s public finances are sound. Monetary policy is clear and credible. Canada’s financial system showed itself to be among the most resilient in the world through the crisis. Since then, it has strengthened further.”

Although exports were affected by unfavourable global economic forces, Canada’s economy benefited from domestic demand and an accommodative monetary policy. Bond rates continued to slide in 2012 as the local stock market was impacted by slowing emerging economies and weak raw material exports.

Outlook for 2013

Global economic conditions are expected to improve in 2013, driven by a combination of fiscal measures announced in the euro zone, an economic stimulus plan in China and robust actions taken by central banks in 2012. That said, the climate is still fragile.

Except for a possible political and fiscal crisis in the U.S., the global economic outlook for 2013 is encouraging. Desjardins, Economic Studies is forecasting economic growth at 3% for 2012 and 3.4% for 2013. While the euro zone is expected to stagnate in 2013, developing economies, primarily China, will grow at 5.1% while the U.S. and Canadian economies will expand by 2%.

Monetary policy in 2013 will remain accommodative in industrialized countries. The U.S. Federal Reserve and the Bank of Canada will hold their key interest rates steady while the European Central Bank will cut their rate by another quarter of a percentage. Tensions in the Middle East have the potential to temporarily push the price of a barrel of oil above $100 (the trading range in 2013 is expected to be $85 to $100). An ounce of gold will fetch an average of $1,900. Against this favourable backdrop, the loonie will stay slightly above parity. The ten-year interest rate in Canada and the U.S. will stand at 2.25% and 2.05%, respectively, at the end of 2013. Last, in 2013, we expect the TSX to close at 14,200 and the S&P 500 at 1,560.

Unless the political and fiscal situation in the U.S. gets out of control, growth stocks are expected to outperform fixed income securities next year. Note that uncertainty over the fiscal cliff has fed investor nervousness and gloomy economic and financial outlooks. Many investors are remaining on the sidelines. Once the fiscal cliff is averted, investors will realize that the global economic and financial backdrop is conducive to growth stocks.

Improvement in balance sheets combined with high liquidity levels and low interest rates have prompted companies to go ahead with capital spending and acquisitions, increase dividend payments and, in certain cases, repurchase their own shares in the stock market. In our view, growth stocks offer a better return potential than other asset classes. The TSX’s dividend yield exceeds ten-year Government of Canada bond yields by 1.16%. Other than in 2009 and recent months, this result has been unseen since World War II.

For balanced portfolios, we recommend the following asset allocation: 5% cash, 35% fixed income and 60% growth stocks. For the fixed income component, we recommend an overweight in provincial, municipal and corporate issues and preferred shares, and an underweight in Government of Canada bonds. In the event bond rates start going back up gradually next year, investors should think about scaling back the weight in long-term bonds and bolstering short- and medium-term issues. This strategy will result in a duration shorter (recommended target: ± 5 years) than the benchmark index.

For growth stocks, we recommend a combination of high dividend yield stocks (REITs, utilities, telecommunications and pipelines) and more risky growth stocks with attractive dividends (finance, technology, industrials, consumer discretionary, transportation and gold).

In the coming years, debt levels in G-20 countries and budgetary measures to reduce such indebtedness will rein in economic growth, raising investor concerns. These conditions call for active management of financial assets.

Michel Doucet is an economist. Prior to joining Desjardins Securities in 2004, he was an analyst for institutional clients and later head of economic research and the fixed-income sector for individual clients with a national brokerage firm. Over his 20-year career, Michel has acquired a wealth of expertise in bond portfolio analysis and management. He is responsible for discretionary management portfolios totalling over $100 million.