Where Is Canada Headed in 2012?

01/27/2012 9:30 am EST

Focus: GLOBAL

Gordon Pape

Editor and Publisher, The Income Investor and the Internet Wealth Builder

After 2011, the year of volatility, predictions of the future need to be heeded with extreme caution…but these six trends are the most likely to continue this year, writes Gordon Pape of The Canada Report.

Every year I make predictions, and every year I look back to see how well I fared on my predictions from the previous year.

At its most basic, the investment world is a series of stability/instability phases. You can make money during both, but different strategies are required.

During periods of stability, patterns and trends are reasonably predictable. Stock markets move gradually higher, interest rates remain relatively constant, risk is measurable, and returns are consistent. You can invest in a security with a realistic degree of confidence in the outcome.

When times are unstable, as they are now, none of the above applies. Stock markets lurch violently from one direction to another. Interest rates move to levels which are either abnormally high, as in the early 1980s, or absurdly low, as they are today.

Investments which in other times would be considered low-risk suddenly seem dangerous. People become frightened and uncertain, often resulting in financial paralysis.

We have been living though such times for most of the young 21st century. We are going to have to endure them for a while longer.

During instability phases, predicting the year ahead becomes even more difficult than usual. There are so many variables in play that trends which may appear obvious in January can shift direction within a couple of months. That’s what happened in 2011.

For example, last January I wrote the following in the first issue of the year: "I expect 2011 to be a good year—perhaps a very good one. The global economic recovery appears to be firmly in place and concerns of a double-dip recession, deflation, and other bogeymen have faded."

That turned out to be as far off the mark as I have ever been in my career, but it was indicative of the degree of optimism that prevailed at the beginning of last year. Memories of the 2008-09 market crash were fading, the economy was growing again, the Bank of Canada had been confident enough about the future to raise interest rates three times, and the debt problems of tiny Greece seemed like a minor irritant.

Of course, that all changed. The March earthquake and tsunami in Japan, followed by the nuclear plant meltdown, critical time. The Greek disease spread to other Eurozone members, eventually hitting some of the continent’s most important economies such as Italy. Growth slowed in China and stalled in the US.

By year’s end, we were in a collective funk once again. Instability reigned supreme.

As a result, many of the specific predictions I made last year were off target. Although it is painful to revisit them now, I have always believed in full disclosure…so here’s what I forecast.

A modest rise in the TSX. Although I cautioned not to expect a repeat of 2009 and 2010, I did foresee an advance of about 10% in the TSX to around 14,775 at year-end. The closest we came to that was a closing level of 14,329 in early April. It was all downhill from there.

Interest rates will rise. This wrong call resulted from Bank of Canada Governor Mark Carney’s persistent criticism of the high debt levels of individual Canadians. I figured he would keep pushing rates higher in 2011 to reduce borrowing demand. I’m sure he would have loved to do just that, but the slowing economy got in the way.

Bonds are dangerous. I sure blew this one. On the assumption that interest rates would rise, I expected bond prices to fall. Rates didn’t rise, and the flight to quality that resulted from the Eurozone mess pushed US and Canadian government bond yields lower and prices higher. As a result, bonds outperformed stocks by a wide margin.

Oil will move through $100. That happened. It didn’t go as high as the $110 to $115 range that I was looking for by year-end, but I was directionally right.

Commodities will be firm. A mixed bag here. Base metals generally declined, but oil rose. I predicted gold would end the year in the $1,600 range; it finished at $1,566.80.

The loonie will hover. After a 5.2% rise in the value of Canadian currency against the US dollar in 2010, I predicted the loonie would stabilize and trade within a few cents of parity for most of 2011. Whew, got one right!

The Outlook for 2012
Having been wrong on so many of my 2011 calls, I hesitate to dip my toe back into these churning waters. There are many potential outcomes to this year, ranging from a plunge back into recession as forecast by noted economist Nouriel Roubini (aka Dr. Doom) to modest growth and a stock market recovery.

Here are my best guesses on how it will all play out…but they come with a warning: given the speed at which things are changing, be prepared to switch your investment gears at any time.

TSX back in the black. I do not expect robust gains on the TSX. But I do expect some improvement, with undervalued oil and gold stocks leading the way up. Look for the TSX to finish the year in the 12,600 range, a gain of about 5% from the 2011 close of 11,955.

Interest rates flat. No central bank in its right mind is going to raise interest rates in the current climate. But there’s very little room to cut either.

Bond boom ends.It’s been a wonderful run for bond investors, but it’s hard to see where future profits might come from, with interest rates so low. I expect about a 4% return from the DEX Universe Bond Index, Canada’s benchmark bond index, this year.

Oil higher. The big story of the year in the energy sector could be an increasingly dangerous Iran. If sanctions truly bite and oil exports are hit, it is hard to predict where and how this regime will respond. The recent saber-rattling over the Strait of Hormuz is certainly cause for anxiety.

Gold much higher. Gold briefly moved through $1,900 an ounce last year before retreating. It could test that level again in 2012. Gold stocks, which have lagged the metal, could be the major beneficiary.

A higher loonie. Rising gold and oil prices should help push the Canadian dollar higher. I expect it will touch US$1.05 in 2012, and will settle in the range of US$1.02 to US$1.03. It should strengthen more against the euro, with the exchange rate dropping to about $1.25 to €1.

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