Interest rates will drive equity returns in 2005: Rubin

By Steven Lamb | January 7, 2005 | Last updated on January 7, 2005
3 min read

(January 7, 2005) Despite predictions of economic slowdown, 2005 should provide equity investors with solid returns, according to an economist from one of the big banks.

“Broad scale exposure to declining long-term interest rates, either through dividend-yielding stocks, income trusts or long duration bonds, should be the key for one’s investment strategy in 2005,” says Jeffrey Rubin, senior economist and senior strategist at CIBC World Markets. “Add to that a healthy dose of skepticism about future oil supply, and investors should have a good shot at double-digit returns.”

Speaking to the Empire Club in Toronto on Thursday, Rubin said the two fundamental challenges facing the TSX — interest rates and exchange rates — are likely to turn out to be paper tigers. He predicted the TSX will finish 2005 around the 10,000 mark, reflecting a gain of about 10%.

“While there is little to suggest the Federal Reserve Board has completed its tightening program, there is much to suggest the Bank of Canada has,” Rubin says. “The Canadian economy does not work at 80 cents. The appreciation of the Canadian dollar is going to provide all the braking power, and even more, than all the intended increases in interest rates which the Bank of Canada so boldly advertised.”

With the Canadian economy suffering the consequences of 2004’s appreciation in the loonie, the Bank of Canada no longer faces the threat of inflation. Rubin points out that the Bank of Canada has ceased talking about raising rates and says the rates spread between Canada and the U.S. will likely reverse.

“Far from the mass exodus from the Treasury market, a weakening greenback has spurred greater central bank buying of long Treasuries, as central banks in China and Japan have to wrap up their buying programs to keep their low currencies in check.” “Until the economies of China and Japan are willing to tolerate significant currency appreciation, they are tied to the long end of the Treasury market.”

Also pressuring the loonie, the European Central Bank will likely show more tolerance of currency appreciation, since European economies rely far less on exports to the U.S. Rubin expects the euro to reach US$1.40, from its current level of about US$1.31. The Canadian dollar should trade in the mid-70-cent range.

As the Bank of Canada cuts rates, Rubin thinks dividend stocks will become more attractive as an alternative. He says many of the traditionally high-yielding companies, including the big banks, are carrying a fair bit of cash and that profit growth will likely lead to higher dividend payouts.

“A 15% rise in dividends last year saw dividend-paying stocks outperform non-paying stocks by a ratio of four to one,” he says. “With dividend payout ratios still low by historic standards and ample free cash, similar dividend growth this year should see dividend payers outperform non-dividend paying stocks by a comparable margin.”

Another beneficiary of lower interest rates should be income trusts, especially oil and gas trusts.

Despite a recent fall-back in the price of oil, Rubin is bullish on crude, predicting an average price of about $50 a barrel. The reasons for this are simple. The “off-shoring” of manufacturing has driven industrial production out of Western Europe and North America, which are relatively energy-efficient economies. Manufacturing is now centered in countries that are very inefficient energy consumers, such as China and Indonesia.

At the same time, the world seems to be reaching a peak in conventional crude production. Non-conventional crude sources will cost far more to exploit, providing a floor price below which crude prices are unlikely to fall.

“Barring a sudden global recession, the energy market is not going to be materially slacker this year than it was last year, or for that matter 2006 or 2007,” he says. “The sudden acceleration in crude demand witnessed over the last couple of years is not a cyclical blip, but a structural shift driven in large measure by globalization.”

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Steven Lamb