Twin deficits in the U.S. make for a challenging second half of the year
Brian Lewis
Province
FRANCES HORODELSKI in the cycle’s sweet spot
This is going to be a year when individual investors and tight-rope walkers share a fundamental requirement for survival — namely, the ability to balance.
For investors, says Scotiabank portfolio advisory-group director Frances Horodelski, that means don’t blindly rush into equities will all your investment dollars just because stock markets in Canada and the U.S. gained more than 20 per cent in value during 2003.
“This time last year, investors were running away from equities in droves because of poor market performance and clearly that was the wrong thing to do,” she said during an interview while in Vancouver last week for her bank’s Economic and Market Outlook 2004 conference.
“But this year, you don’t want to be running totally towards equities either. You’ll need balance in your portfolio.” To build that balance as the annual RRSP seasons hits its stride, investors should focus on areas such as interest rates, the Canadian dollar, the economy and corporate profits, Horodelski suggests.
“We think the Toronto Stock Exchange and the S&P 500 could appreciate by 10 per cent this year which is about half of last year’s performance,” she adds. “However, we also think that these targets may be reached sooner rather than later so I expect that the second half of this year will be tougher on investors than the first.”
Earl Bederman, president of Toronto-based Investor Economics Inc., agrees that the past year’s market performance won’t be duplicated in 2004. “It’s my belief that the easy gains are behind us and that investors are in for a bumpy ride,” he said recently.
“While I still strongly believe that we are in the early stages of an extended bull market, I am feeling somewhat queasy about market prospects over the next several quarters.”
Horodelski, meanwhile, bases her forecast for a weaker second half in 2004 on several factors. She says in the U.S. it’s likely that consumer spending will begin to loose some steam later in the year as benefits from tax cuts and mortgage refinancing diminish. The massive U.S. twin deficits — trade and fiscal — will also put upward pressure on borrowing costs.
“We’re now in the sweet spot of the current economic cycle and that should last until near year-end, but equity markets tend to anticipate changes like this and that’s why I think the second half of 2004 will be more challenging for investors than the first half.”
Horodelski also says last week’s quarter-point cut in interest rates by the Bank of Canada — and the likelihood of another quarter-point cut in March — is a “double-edged sword” for investors.
“Lower interest rates are the bane of investors because it means that keeping your money in the bank or in GICs isn’t very attractive. But, on the positive side, low interest rates stimulate the economy,” she explains. “That’s good for corporate profits which in turn is good for equity markets.
“Corporate profits are rising again,” she adds, “and companies are also spending again. They’re re-investing in their businesses and that’s positive.”
In fact, a recent economic study by the Conference Board of Canada shows that growth in machinery and equipment investment will lead all categories of business investment in 2004, weighing in at a hefty increase of 9.5 per cent.
She says sectors such as industrial products, technology, telecommunications and software are all expected to see strong market growth this year. Health care and consumer staples are also worth watching.
“With reference to bonds and cash, our forecast for modestly higher interest rates later in 2004 supports our view that investors should position the fixed income portion of their portfolio in the five-year segment of the market where the highest return is expected,” she adds.
Scotiabank is recommending an asset mix of roughly 60 per cent equities and 40 per cent bonds and other fixed income securities. Because interest rates are low, keep your cash level at a minimum.
Scotiabank economists also forecast that the slight rise in interest rates will be accompanied by a reduction in the spread between Canadian and U.S. rates (see chart) which will in turn put some downward pressure on the soaring dollar.
That will will help Canadian exporters to generate improved profits. Equity investors should also concentrate on high-quality, relatively stable stocks, companies that have strong business models, earnings growth and growing dividends.
“Overall we remain constructive on 2004 with many opportunities available to achieve attractive returns,” Horodelski says.
“But as the tide raised almost all ships through 2003, this year will require a greater amount of selectivity.”
That goes for mutual funds as well.
Horodelski says if you’ve got just a small portfolio then a balanced fund is best, but larger portfolios can accommodate pure equity and specialty funds.
“The important thing in the mutual fund arena is to make sure you’re not overly-diversified,” she cautions. “Too many people have way too many mutual funds.
“And, of course, don’t buy a fund based on last year’s performance.”
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