Analysts predict bumpy market ride

By Mark Noble | January 4, 2008 | Last updated on January 4, 2008
5 min read

Advisors looking for some consensus on where to allocate their client assets are probably going to want to steer clear of financial stocks, according to 2008 market forecasts presented at the Empire Club in Toronto. Other than that, this year’s markets, like last year’s, will likely provide a wild ride.

It seems the big X-factor in 2008 will continue to be the extent of the damage from the U.S. sub-prime loan market and how that affects global credit markets.

“There will be a lot of volatility, which will be favourable to active traders,” said Don Drummond, senior vice-president and chief economist at TD Financial Group. “The volatility will come as companies reveal their asset exposure to risky markets. We haven’t even begun to scratch the surface of where all this sub-prime debt is located around the world. We will get a much better picture as we get more revelations like those we have been getting since the summer.”

Drummond was optimistic about the market’s ability to bounce back from the sub-prime crisis.

“I am presuming that there will not be a major financial system collapse, and the world economy will get through, albeit with somewhat slower growth,” he said. “Equity markets seem to be appropriately priced. With most of the economies, you should see about 7 to 8% in growth in their equity markets. That is probably a little bit better than you might think in a consensus forecast looking at the doom and gloom from the economy. Remember a lot of [doom and gloom] is already factored in [prices].”

In fact, Drummond thinks investors should be taking a second look at the U.S. market, which he believes has a lot of fundamental strengths.

“We are all seized by the sub-prime [issues] — what that’s doing to the residential housing sector, but that’s only one twentieth of the economy. So that’s not a big deal,” he said. “There are offsets. Government spending has been going at a fair clip; business investments in corporate balance sheets are in great shape. Exports are growing much faster than imports.

However, Drummond is pessimistic about the value of U.S. financial service stocks.

“There is a great deal of uncertainty and it is coming from that financial side. If you look at a lot of those big investment houses and those type of assets, they are triple and quadruple their amount of capital. They could face write-offs in the one-third range, which means they might not be worth that much,” he said.

Donald Coxe, global portfolio strategist for BMO Financial Group, dismissed financials, which he also avoided last year. He expects financials to continue to slide and commodities to boom.

“Just as last year, the worst group to be in was the financial stocks and the best group to be in was the commodities because commodities are real things,” he says. “Our formula for investing is to invest in unhedged reserves in the ground in politically secure areas of the world. Last year, we added a new asset class group started by mining and oil, which were the agricultural stocks.”

To say Coxe is bullish on commodity stocks — agricultural ones in particular — would be an understatement. Coxe’s view on emerging market demand for commodities takes an almost apocalyptic tone. He believes demand from the emerging markets has driven oil and mining prices to record highs and now he expects food prices to skyrocket in 2008, leading to a global crisis.

“The new middle class [in emerging markets] wants to eat the way our middle class does, and that means we have to expand food output dramatically. This despite the fact that we have had a 17-year winning streak in the U.S. Midwest in growing weather, which is where 53% of the world’s corn is produced,” Coxe said. “At some point that winning streak will end, and then we’ll have a food crisis that in economic terms will be the greatest we have ever seen. That’s the downside.”

Coxe said there is a big upside though for those who invest in agricultural stocks now.

“There are about two dozen stocks in the world that are going to redefine the world’s food supply. Those stocks will have a precious value as we move forward. For any investment formula for the coming year, I will simply say this: the cornerstone of any investment strategy must be to recognize food price inflation is coming,” he said. “It’s going to hit this year hard. We have a year-over-year growth in U.S. raw food costs of 22% and 6% at the consumer level, but this bulge in the pipe is gradually going to work its way through the system. You should therefore be fully hedged by having access to those stocks that benefit from rising food prices. That’s a good start.”

Nick Berisheff, co-founder and president of Bullion Management Services, is also an advocate of a return-to-the-earth approach to portfolio construction. Given that his company specializes in gold investing, it’s probably not surprising he was touting to increase precious metal holdings in the coming year.

“In 2008, we have gold forecasting ranging from $725 to $1,100 an ounce. It won’t matter if it is $700 or $1,100 in the long term,” he said.

Berisheff believes gold, silver and platinum prices are reaching unprecedented levels because banks and investors are increasing their holdings as a currency hedge against inflation. Central banks are infusing huge amounts of money into the financial markets to stave off the credit crisis. He said the money supply has increased by 8% in Canada, 12% in the U.K., 12% in the E.U., 14% in Mexico, 16% in Brazil, 18% in China, 21% in India and 42% in Russia.

“The money supply of the U.S. dollar, the world’s reserve currency is growing at an unprecedented rate of 16%. Since 2005, the world’s [U.S] money supply has increased from $10 trillion to a staggering $13 trillion,” he said.

Berisheff notes this infusion has an obvious huge inflationary impact. He also highlighted that the current Consumer Price Index, which has been hovering around 2%, is not always the best indicator of inflation. Using its pre-1990 methodology, he says inflation is somewhere more in the vicinity of 8%.

“In establishing asset allocations in the coming year, I think a realistic view of inflation is important. Real wealth management must take into account inflation. If real inflation is already 8%, then long-term bonds are not really a safe investment but rather a guaranteed loss of purchasing power,” he said. “Studies have concluded gold, silver and platinum are the best leading indicators of inflation, and of the three metals, platinum is the best. Platinum has increased 37% in 2007.”

Berisheff also said similar studies suggest that investors look at allocating 7% to 15% of their portfolios toward precious metal stocks.

As gold, silver, and platinum continue to rise there will be a reallocation from financial assets, which now exceed $187 trillion, to precious metals by mainstream investors. This hasn’t happened yet. Since aboveground supplies are less than $4 trillion and there is only $600 billion in private supplies, we are going to see substantially higher prices,” he said. “When this reallocation takes place, gold at $1,100 an ounce will look like a bargain.”

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Mark Noble