Counting Canada's Blessings

12/07/2009 9:13 am EST

Focus: GLOBAL

Gordon Pape

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

A solid banking system and mineral riches should underpin decent stock-market gains in Canada next year, writes Gordon Pape in the Internet Wealth Builder.

We have just come through perhaps the most traumatic 12 months that most investors have ever experienced. (The exceptions are those old enough to remember 1929-30.) A [little more than a] year ago at this time, we were facing what looked like financial Armageddon. The world banking system was crumbling, credit had seized up, and talk of a 21st century Great Depression was everywhere.

People were bailing out of the stock market for the safety of cash and government bonds, and many remain on the sidelines to this day. Their nervousness is exacerbated by doom-and-gloom pundits who flit about like Halloween goblins, warning of more catastrophes to come.

Thus far, the markets have chosen to ignore the fear mongers. If stock markets are truly leading indicators (and there is some debate on that score), then 2010 should turn out just fine.

That's not to say there aren't more hurdles to overcome. Here in Canada, the loonie continues to worry our central bankers, we're facing years of budget deficits and spending cuts, the country is experiencing trade deficits for the first time in years, unemployment remains stubbornly high, and the spreading swine flu virus may affect fourth-quarter gross domestic product (GDP).

In the US, the housing market still has not recovered, the banking system still looks fragile, runaway government deficits make our politicians look like fiscal geniuses, there are concerns the commercial real estate market will implode, and on and on.

A wall of worry? How about a mountain?

Still, I look at [Canada's] solid banking system, now held up as an example for the world, and thank heaven for our innate caution when it comes to our basic institutions. I look at our abundant resource wealth and marvel at our good fortune to live in such a richly endowed land. I give thanks that our politicians, with all their faults, had the good sense to run more than a decade of surpluses, storing up credits for the rainy day that finally came.

It all adds up to cautious optimism when I look at the year ahead. There will be surprises, of course, both good and bad. But this is what I expect to happen, based on current trends.

1. The loonie will remain strong. I can see no reason why the loonie will drop in value next year, unless we experience a world double-dip recession, which I do not expect. Whether we like it our not, [the Canadian] dollar has become something of a petrocurrency, and if oil prices continue to trend higher, which I think they will, that will provide further upward pressure on the loonie. I would not be surprised to see us at parity with the US dollar or perhaps slightly higher for most of the year. I do not believe the Bank of Canada has the tools to prevent that; the best it can do is slow the rate of increase.

2. Inflation will resurface. The Bank of Canada is predicting a "modest recovery" that will result in an increase of 3% in GDP next year and 3.3% in 2011. Deflation should give way to a gradual rise in inflation early next year, moving towards the bank's target rate of 2% by year end.

3. Interest rates will rise. Bank of Canada Governor Mark Carney has repeatedly reaffirmed the commitment to hold the key overnight rate at a record low 0.25% until the end of June 2010. I expect that he'll stick to that; however, shortly thereafter, rates will start to move up. Bond prices will weaken in advance, with government issues the most vulnerable.

4. Gold will remain strong. I have never been a gold bug, but it is difficult to see any significant drop in the price of bullion in the face of a weakening US dollar and increasing talk of replacing it as the world's reserve currency.

5. Market growth will slow. We are unlikely to see a repetition in 2010 of the explosive stock market rebound we have experienced since March. There is still money to be made, but investors will need to be more selective. We could see some earnings disappointments as the strong loonie cuts into corporate profits.

At this stage, my view is that the TSX will post gains in the low double-digit range (10% - 12%) in 2010, ending the year in the 12,000 to 12,200 range. However, there will be a lot of volatility along the way, so you will have to have a strong stomach at times.

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