Downside risks grow as stocks grind upward

By Satish Sarangarajan | December 12, 2014 | Last updated on December 12, 2014
4 min read

It’s been a good year for stock markets. Accommodative central bank policies, record-low interest rates and a thirst for yields have sent the S&P/TSX Composite about 11% higher this year. For good reason: corporate earnings are robust; balance sheets are in decent shape. And an improving U.S. economy and a weak Canadian dollar portend more gains ahead.

But the run-up comes amid simmering geopolitical tensions, weak commodity prices and slower global growth.

“We see a lot of challenges for the markets next year, particularly slower global growth,” says Philip Petursson, managing director, portfolio advisory group at Manulife Asset Management in Toronto.

South of the border, strong GDP growth and an improving labour market have set the stage for an interest rate hike in 2015. But offsetting that are fears of slackening growth in resource-hungry China, broad weakness in emerging market economies, and stagnation in Japan, where attempts to get the economy growing have disappointed investors. And in Europe, the European Central Bank is buying covered bonds and asset-backed securities, and has signaled it could buy government bonds.

More stimulus will undoubtedly mean more opportunity in Europe, where some of the banks and industrial companies could benefit.

But businesses are taking out fewer loans, and that, coupled with high valuations and flat money supply growth, will likely cap returns, Petursson says.

Stephen Wood, chief market strategist for Russell Investments in New York, says U.S. markets are still a good bet. “The U.S. Federal Reserve policies are still accommodative and inflation is still very low, which is a good place to be.”

While the risk-return equation isn’t as great as it was a few years ago, Wood says the economic environment is generally positive for U.S. stocks. By contrast, the resources-heavy TSX, weighed down by a slump in mining and energy exploration, could struggle to match U.S. markets as expectations of weaker global growth hurts commodity prices more.

Martin Murenbeeld, chief economist at Dundee Capital Markets in Victoria, B.C., says commodity prices tend to slip when global growth expectations fall below 4%. In October, the IMF cut its 2015 forecast for global GDP growth to 3.8%.

And if the Fed raises interest rates next year, as expected, Canadian markets could hit a rough patch.

Petursson pegs the probability of a correction in stocks during the first year of tightening at 60%, which is about double that of a normal year. Conversely, the average upside of markets rising in the first year of tightening is 6%, compared to 8% normally.

“The thesis of a longterm bull market is still in place,” Petursson says. “But, overall, the risks for short-term downside volatility have moved higher.”

Is gold still a safe haven?

No discussion on Canadian markets is complete without a mention of gold, since the S&P/TSX Composite houses five of the world’s 10 biggest gold miners.

Canadian miners, and gold producers in particular, have had a horrid few years as metals prices have fallen, making gold a money-losing proposition for most investors. Bullion prices, which plunged nearly 30% last year, could end this year with double-digit declines. And, chances are that 2015 won’t be much kinder. Gold could go higher next year, as violence could escalate in the Middle East and growth skid in Europe and China. But those factors could be trumped by higher interest rates in 2015—a big negative for bullion prices.

“Is gold a safe haven? The short answer is yes,” says Martin Murenbeeld, chief economist at Dundee Capital Markets in Victoria, B.C. “But that doesn’t mean gold will always rise in dollar terms.” He predicts gold prices will average US$1,235 in 2015.

Among other factors, Murenbeeld cites the steep fall in the bullion stockpiles of ETFs as a reason for the bearishness. The instruments’ gold holdings are down to 1,648 tonnes in 2014, from 2,633 tonnes at the end of 2012.

“There’s been a significant drop in the desire to buy gold in the western world,” says Murenbeeld.

“The thinking goes, when the equity markets are this hot, who cares about gold?”


Source:, Bloomberg, Dundee Capital Markets Economics

Economy on firmer ground, but risks remain

As the year draws to a close, we revisit the forecasts we published last year to see how we fared.

After distinctly underwhelming GDP growth the previous two years, economists predicted economic growth a little over 2%, amid what could be best described as cautious optimism.

Back-of-the-envelope calculations show the economy likely expanded 2.5% this year.

As for economists’ 2015 expectations, we once again found cautious optimism. The economy should grow between 2% and 2.7%. The stronger outlook comes amid a much-awaited uptick in exports, which were boosted by a weakening Canadian dollar, expectations of improved business investment and a big job rebound in the autumn.

Douglas Porter, chief economist at the Bank of Montreal, says “we shouldn’t overlook the many economic positives that are already staring us straight in the face,” in a note to clients. BMO expects the economy to grow 2.4% in 2015.

Royal Bank of Canada forecasts the economy to grow 2.7% next year, which is higher than its 2014 forecast of 2.3%. In a report, RBC’s assistant chief economist, Paul Ferley, says cheap oil, the strengthening U.S. economy, a weaker loonie and lower energy costs will help the non-energy export sector.

However, David Madani of Capital Economics sees lower crude oil—Canada’s biggest export—extremely high house prices and heavy household debt weighing on the economy next year, especially if interest rates rise. Madani forecasts 2% GDP growth in 2015, unchanged from his forecast for this year. “The risks are slightly to the downside,” he says.

by Satish Sarangarajan, a Toronto-based financial writer.

Satish Sarangarajan