January 2014 – Executive Summary – 2013 in Review and our Outlook for 2014

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 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.

Leading indicators:

  • 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: average hours worked, the rise and fall of output
  • For stock prices: changing levels of profits, and subsequently changes to dividend
  •  For economists: money supply, showing cash reserves and interest rate trends

Lagging indicators: 

  • Employment,
  • Private sector spending on plant and equipment.
  • Business borrowing – are interest costs increasing or decreasing
  • Actual labour costs
  • Inflation as measured by the Consumer Price Index “CPI” and the “Core CPI”

Coincidental indicators: 

  • Personal income
  • GDP or Gross Domestic Product
  • Retail sales

We are the receivers and readers of many market commentaries, economic outlooks and expecta-tions. 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 improve-ment 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.

  • We do not expect an interest-rate change in the first half of 2014.
  • A mild back-up in bond yields of 50-75 basis points (or . to . of 1%) for longer dated bonds
  • A stronger economy in the US than in Canada will continue to provide the basis for a weaker Canadian dollar – benefits Western Provinces compared to Eastern Provinces.
  • Canadian housing to remain stable and the consumer to remain relatively optimistic, thanks to low interest rates

So, as our first Prime Minister Sir John A MacDonald was heard to say, “Look a little ahead, my friends”

Some of the best themes and advice we have read for 2014 are:

Be an owner not a lender. This favours stocks over bonds.

Cash is trash. Maintaining the purchasing power of a dollar is critical.

The stock market rally with extend to Large and mid-cap stocks 

Corporate spending will increase – particularly capital expenditure in technology

Watch the curve: Watch the yield curve that is. Keep bond maturities

Look across the pond: Emerging markets may be poised to outperform in 2014.

All that glitters is not gold: Gold is deflation protection, and we expect some modest inflation

Writers note: To find out why we are so interested in emerging markets, attend our January 21st seminar being held at Otello’s Banquet and Conference Centre in Oakville at 7 pm. Our guest speaker is Christine Tan, Portfolio Manager, Excel Emerging Markets Fund. This event is sponsored in part by Excel Funds Management Inc.

I was recently reminded of a fundamental investment lesson. One of the most significant return indicators are the dividends or dividend yields paid by companies. We love dividends as they provide great insight into the profitability of a company, and provide insight into profitability trends for the future. One of the leading indicators that we have watched in 2012 and 2013 has been the dividend rate paid by companies. Many companies that we watch and track have increased their dividends in the past year. This is an indication that these companies continue to see profitability ahead and more importantly, increasing profitability. When a company, mutual fund or exchange-traded fund that we own raises its dividend, we cheer as we are being paid more simply for holding and doing nothing.