January 2014 – 2013 in Review and our Outlook for 2014

I have had the “pleasure” of teaching not one, but four teenagers how to drive. Needless to say, they are finding out that driving is not so simple a task and that there are plenty of distractions – as well as what seems to be conflicting information. Our teens recently obtained their G1 licenses, and are taking every opportunity to practice their new ‘skills’.

If you drive a vehicle, you know that there are so many things going on at any one time. You have to be looking ahead through the windshield, looking towards activity in front of you. But at the same time you must be monitoring your rear-view mirror and side mirrors to constantly monitor activity beside and behind your vehicle. Add to that, you must also be aware of what is going on inside your vehicle, looking at your dashboard, particularly speed. You also have to track your direction and distance to your destination keeping an eye on your fuel, on top of being aware of street signs, traffic signals, highway signs and weather.

Investing, much like driving, means needing to be able to anticipate markets and market trends by looking ahead and around you. Anticipating market trends is not a fine science. It is the ability to read some very conflicting indicators, those defined as leading indicators that help to shape our perspective of things to come, and lagging indicators that help us to confirm or understand things that have happened. In the financial markets, leading indicators can be:

  • Housing starts
  • Manufacturing data (such as new orders, and higher levels of consumer purchases)
  • Commodity prices as they rise and fall based on demand for raw materials
  • For employers and employees: understanding the average hours worked, the rise and fall of output, which help employers to anticipate changes in employment
  • For stock prices: the changing levels of profits, and subsequent to that, changes to dividend payouts (rising or falling)
  • For economists: money supply is a major indicator as it helps to understand available cash reserves and the impact or future trend of interest rates

Lagging indicators are those that change once the economy as a whole changes. They basically confirm that a business cycle is performing normally or perhaps abnormally. Lagging indicators can be:

  • Employment, the most popular lagging indicator, because rising unemployment is an indication that the economy is doing poorly or that employers anticipate a downturn in the economy
  • Private sector spending on plant and equipment. When companies spend here they expect to gain a return on their spending, and when they defer spending, they indicate concerns
  • Business borrowing and whether interest costs are increasing or decreasing on those borrowings
  • Actual labour costs
  • Inflation as measured by the Consumer Price Index “CPI” and the “Core CPI”, which is the CPI excluding food and energy prices

The challenge when looking for leading or lagging indicators is that when an economy is in transition, leading indicators may provide conflicting information for a period of time, and lagging indicators may only provide insight too late to make a meaningful difference in investment allocation and strategy. For this reason, we look at “coincidental indicators”, which serve to give us a reading on the state of the economy, or a view of things to come. These indicators would be;

  • Personal income
  • GDP or Gross Domestic Product – the sum of all goods and services produced over a time period
  • Industrial production
  • Retail sales

We are the receivers and readers of many market commentaries, economic outlooks and expectations. The following is the average economic expectations for 2014 as reported by the largest Canadian Banks’ economic groups;

  • Personal income to rise 3.1% which is unchanged from 2013
  • GDP to rise 2.3% in 2014 (up from 1.70% in 2013)
  • Industrial production in 2014 to rise 1.70% (up from 1.20% in 2013)
  • Retail sales in 2014 at 2.2% (which would be down from 3.6% in 2013)

Given the coincidental indicators above, we expect 2014 to fall neatly into place for a marked improvement for Canada in the year ahead. We believe that Canada is poised to continue its strong showing in 2014, but as always, this is dependent on better or improving US Growth. We expect that the lackluster domestic backdrop and low (wage) inflation will keep the Bank of Canada holding interest rates low for most of the year. The economic underperformance relative to our major trading partner (USA) will keep the Canadian dollar trading below the value of the US Dollar. This is good for Canadian manufacturers but not so good for Canadian consumers, which is reflected in the economic expectations above, particularly Industrial production and retail sales.

In early December, the US Federal Reserve announced that they would begin to taper their bond purchases from $85 Billion per month down to $75 Billion per month. Janet Yellen, the new Chair of the Federal Reserve has indicated that she is in no hurry to change policy in the immediate future. As such, we do not expect an interest-rate change in the first half of 2014. Some market professionals that we track (bond-traders) would predict only a mild back-up in bond yields of 50-75 basis points (or ½ to ¾ of 1%) and for longer dated bonds (think bond maturities 10-30 years from now), we would agree.


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