Favour equities over bonds in 2016: analysts

On the markets

At TD Wealth, analysts are favouring stocks — especially dividend growth stocks — over bonds. Dividends will be necessary to boost returns in what TD predicts will be a muted environment, with average investments reaping “low to mid-single-digit” returns. TD also prefers developed markets over emerging ones, though analysts don’t have a preference for one developed market over another. The bank does note that prices in emerging markets will be attractive this year as those countries continue to struggle.

On bonds, TD is overweight investment grade corporate bonds, compared to government bonds. That’s because of these corporate bonds’ incremental yield and shorter duration. The team is cautious about high yield bonds this year.

Overall, TD expects a year of greater volatility. They cite emerging market risk, high household and government debt, and central banks who don’t have much room to maneuver as factors that could contribute to volatility.

Unigestion analysts say low commodity prices, emerging market underperformance and a surprise increase in inflation could challenge markets in 2016.

Read: Expect sell-offs in 2016

It’s not just Canada and the U.S. who are feeling the effect of the oil slump: Saudi Arabia needs oil to be at US$98 in order to balance its books. As for emerging markets, which have been struggling, the worst may not yet have come. “Growth could potentially deteriorate further, and then contaminate the rest of the world,” write Unigestion analysts in their 2016 analysis. That would mean less world trade, which was already lower than 2011 levels in 2015. On inflation, the market has so thoroughly priced in low rates that any increase – sparked by oil prices recovering, for instance – take markets by surprise. Unigestion says it’s unlikely, but the “tremendous impact” this would have means it shouldn’t be completely discounted.

Unlike TD, Unigestion prefers European and Japanese stocks over American ones, because the Eurozone and Japan are increasing quantitative easing while the U.S. Federal Reserve is winding its program down.

But like TD, Unigestion also favours equities over bonds, because of low yields. Among government bonds, Unigestion prefers those of commodity-exporting countries such as Canada and Australia.

Read: Industry leaders expect weaker economic conditions: IIAC

A look ahead at the big picture

At Russell, analysts are cautious about Canada’s GDP growth, predicting it to come in between 1.2% and 1.6% this year. They say that driving that growth will be exports, government and household spending.

To truly have a robust export sector, that would require manufacturing capacity to increase, which the analysts say will necessitate the Canadian dollar staying low for a while – something that looks likely to happen. Russell predicts it will move between 70 and 77 cents U.S. all year.

Relying on household spending to drive the economy continues to be troubling, as people’s debt-to-disposable-income ratio currently almost 167%. “We believe overextended household finances pose the greatest risk to the economy beyond low oil prices — and they are potentially more disruptive,” says Shailesh Kshatriya, director of Canadian strategies at Russell Investments Canada, in the firm’s 2016 investor’s note.

Read: 3 economic numbers to watch this year

They also expect the Bank of Canada’s key interest rate to stay at 0.5% all year. “However, if GDP growth is at risk of coming in below our already conservative forecast, an additional rate cut would not surprise us,” says Kshatriya. In the U.S., Russell analysts expect the Federal Reserve to continue increasing interest rates, reaching as much as 1.5% by the end of the year.

What many are hoping will boost the economy – a sudden and unexpected increase in oil prices – wouldn’t truly be the quick fix people are hoping for, adds Kshatriya. That’s because it takes time for increased prices to have a positive effect on the rest of the economy. “So unless oil prices accelerate over the immediate near-term, only moderate growth is to be expected from the domestic economy in 2016,” he says.

The Eurozone will fare slightly better than Canada in 2016, with expected GDP growth of 1.5% to 2%. Ahead of the pack is the U.S., which Russell expects to grow by 2% to 2.5%. It will be another bad year for emerging economies, however, as they continue to suffer under low commodity prices.

Read: BoC may cut rates again by mid-year: experts