(Excerpted from 2011 Outlook - pdf file)
By David Baskin
Central bankers around the world have kept administered interest rates very low. Deposits of up to 90 days earn almost no interest in the U.S. and pay less than 1% in Canada. Canada five year bonds have dropped from a yield of 6.5% ten years ago to a present yield of about 2%. Ten year bonds have fallen from 6.5% to under 3%.
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Bonds in the U.S. are even less rewarding, with ten year Treasuries paying 2.65%. These very low levels reflect slack demand for business investment purposes.
Our Expectations in Regard to Interest Rates
- The fear of a “double dip” recession and deflation in the U.S. economy will keep monetary policy at very accomodative levels. Coupled with quantitative easing by the U.S. central bank, interest rates will remain low across the yield curve in the U.S. and will be mostly unchanged in Canada for the first half of the year.
- Short term deposits will likely yield less than 1.5% for 2011.
- Five year Canada bonds will likely yield less than 3% for 2011, but should start to rise after mid-year.
- Lower quality investments such as BBB rated corporate bonds and convertible debentures will continue to find willing buyers who are prepared to sacrifice some degree of credit quality to generate higher yield. This will keep the spreads between corporate bonds and government bonds at low levels.
- Preferred shares will remain at high levels in 2011 as their tax-preferred dividends will compete favorably with low bond rates. In 2012 and later years they will come under pressure, particularly issues with long or no maturities.
- In the longer term we expect to see interest rates rise starting in the second half of 2011 and continuing into 2012 and later years. We expect to see rising inflation in both the U.S. and Canada, leading to significant increases in both short and long interest rates. For the next year, short maturities are to be favored.
Our Expectations in Regard to Currencies
Exchange rates are notoriously difficult to forecast, and this is particularly true in times of economic stress. However, currency risk is an important factor in constructing a portfolio and adverse changes in exchange rates can destroy the advantages to be gained from international diversification. This is our best guess, but like all currency forecasts, it is very far from certain.
- Commodity prices will rise in 2011 and will accelerate as inflation takes hold. This will benefit the “commodity currencies” such as the Canadian and Australian dollars at the expense of the US$ and the Euro.
- Meanwhile the heavily indebted governments of Europe and the United States will attempt to ease their external debt situation by debasing their currencies.
- The Chinese will be forced to accept a gradual but inexorable upward movement of the yuan, making imports more affordable for the growing Chinese middle class but making exports to North America and Europe more expensive.
- We expect to see the Canadian dollar average about par with the U.S. dollar during 2011, and we expect to see it above par in 2012 and beyond. This will result in some currency losses for Canadian investors in U.S. securities.
- The Canadian dollar, currently at .71 Euros, should rise to about .75 Euros in 2011 and to .8 Euros or higher in 2012. This will make investing in Euro area stocks vulnerable to some degree of currency loss as well.
Our Expectations in Regard to Canadian Stocks
- High quality stocks with a record of increasing dividends will remain in high demand. With Government bonds offering scant returns, blue chip dividend stocks have seen strong price rises. Even so, they offer much better yields than bonds. The twelve securities shown below yield 4.2% on average, more than twice the yield on the Canada five year bond. Where income is taxable the yield advantage is even greater.
- Banks will be raising dividends in late 2010 and 2011 and will continue to show better profits as recession-related problems dissipate and trading and underwriting revenues improve.
- Telecoms will continue to benefit from rapidly accelerating demand for new services which require higher bandwidth and increased levels of service.
- In spite of environmental concerns, pipelines will have increased expansion opportunities related to the oil sands and new natural gas fields.
- Utility companies will remain the most consistent companies in Canada with annual increases in dividend payout expected from most of them.
- We expect commodities to show continued increases during 2011, and accelerated increases in 2012 and beyond. This will favor oil companies (more than gas producers), base metals producers and fertilizer producers, but not lumber or pulp and paper companies which will continue to see low demand.
- Real estate companies will start to benefit from increased prices for commercial and industrial real estate as the economic recovery continues in 2011. In 2012 and later years they will be seen as inflation hedges and should see higher investment interest.
- Manufacturing companies will continue to see increased competition from sophisticated Asian companies in South Korea, China, India and Japan, and to some extent from Brazil.
- Quality retailers should see above average growth in 2011 as consumer spending increases.
Our Expectations in Regard to U.S. Stocks
- Branded merchandise may find increased demand from the rapidly expanding and increasingly wealthy middle class consumers of China, India, Brazil and Mexico. This will favor large multinationals.
- Technology companies such as Cisco (NASDAQ:CSCO), Microsoft (NASDAQ:MSFT) and Google (NASDAQ:GOOG) will benefit from infrastructure replacement and renewal and increased demand for faster, more internet-capable devices.
- Business investment will increase as the economy recovers, favoring large capital goods companies such as General Electric (NYSE:GE).
- Dividend payers will be in demand, as they are in Canada.