finance | BCBusiness
Economic indicators suggest upward momentum for stocks and bonds continuing into 2014
The past year has been marked by record high stock-market performances and signs of cautious growth in some of the world’s economies. While this has been encouraging, investors in B.C. and elsewhere are wondering whether some of the momentum of 2013 will carry over into next year. Here are our thoughts:
Leith Wheeler expects a gradual improvement in global economic growth and we forecast increases in the two-to-three per cent range. Part of the improvement will come from Europe, which, despite pockets of weakness, is starting to grow again after its deep recession. Emerging markets are also beginning to improve, while concerns about China’s slow growth are receding. The most significant change, however, is in the U.S., where the housing sector continues to get stronger. Housing starts have been much lower than long-term demand and the number of building permits is beginning to increase. Low mortgage rates and improved housing prices are helping to release years of pent-up demand. This sector’s contribution to the economy will also help restore consumer confidence and spur spending.
The biggest determinant of global growth is the potential impact from corporate investment in plant and equipment. Business confidence has been somewhat contained due to tepid sales growth and uncertainty over the U.S. budget and debt ceiling. However, there are some encouraging signs that things are getting better, particularly in the oil and gas sector and some parts of the American manufacturing sector. Even with an improvement from depressed levels, capital spending will grow at a slower pace than in previous recoveries.
Most major stock market indices in North America touched all-time highs in 2013. This has raised concern that stock valuations are being inflated by money-printing by the U.S. Federal Reserve. However, it’s our view that the primary driver of stock market valuations has been corporate profit growth, not the Fed’s actions. Most of the reserves that have been created to purchase bonds continue to sit on bank balance sheets in the form of excess reserves. In effect, banks are choosing to continue to hold the increase in money supply rather than using the funds to support new loans. Economic growth and inflation will remain curtailed as long as lending activity remains subdued.
We think stock-market valuations can be sustained in 2014 through reasonable growth of corporate profits. Revenue expectations are improving as market participants get more confident with global growth. Over the last several years, companies have got their balance sheets in order and are now refinancing their debt at cheaper rates, further helping their profitability. Finally, capital is being returned to shareholders though increased dividends and improved stock buybacks. These signs point to stock market returns in the range of six to eight per cent annually over the next several years.
We expect the Federal Reserve to gradually taper the pace of bond purchases, starting in the first quarter of 2014. These actions will lead to higher interest rates. However, we expect any increase in bond yields to be moderated until the Federal Reserve begins to increase the Federal Reserve fund rate. Given the Federal Reserve’s threshold for the unemployment rate of 6.5 per cent and expectations for modest inflation, we doubt this increase will occur until later in 2015 or early 2016. This environment of gradually normalizing interest rates suggests returns in the two to three-per-cent range over the next several years for the Canadian bond market.
Overall, the best way to build financial wealth amid the economic conditions we foresee in 2014 is with a long-term investment approach. For instance, when assembling a stock portfolio, we think like the owners of the companies we might invest in and ensure that the price we pay represents good value. In addition, we are still finding value in short and mid-term corporate bonds and select preferred shares. A balanced approach that combines a portfolio of well-researched stocks with attractive fixed-income investments continues to provide the best trade-off of risk and return.
Jim Gilliland is CEO of Leith Wheeler Investment Counsel Ltd. in Vancouver. This article is not intended to provide advice, recommendations or offers to buy or sell any product or service.