The Canadian Crystal Ball

01/17/2011 12:01 pm EST

Focus: GLOBAL

Gordon Pape

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

Toronto stocks could lag New York for the first year in eight even as crude hits $115 a barrel, writes Gordon Pape in the Internet Wealth Builder.

With fingers crossed, let me begin by saying that 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.

Of course, any cheery predictions can quickly be shattered by unexpected events such as a major terrorist attack on the West, war on the Korean peninsula, or Iran testing a nuclear bomb. And there are serious financial problems still to be resolved including ongoing sovereign debt issues in Europe, the budgetary mess in Washington, continued weakness in American residential housing, and a seriously overextended US commercial real estate sector.

But the fact is that we've come a long way from the fall of 2008 when for a time it appeared the world's financial system was teetering on the brink of collapse and a new Great Depression loomed.

The encouraging trends we have seen over the past 18 months are not going to be easily reversed. In business, as in investing, momentum counts for a lot and right now it is positive.

This is not a year to hunker down in money market funds or to seek safety in government bonds (which in fact rate high on the risk meter). It's a year to look for opportunities and I think there will be a lot of them.

Tiring in Toronto
I expect a modest rise in the TSX [Canada’s benchmark index--Editor.] We've enjoyed two consecutive years of double-digit growth for the S&P/TSX Composite Index: 30.7% in 2009 and 14.4% in 2010. I expect profits again this year but at a more modest level. Resource stocks have a very strong run (the materials sector was up 35.8% last year) while bank stocks appear to be close to fully priced. Resources and financials make up the bulk of the TSX, so without strong advances in those sectors, overall gains will be restrained. I expect to see an advance of about 10% this year, which would take the index to around 14,775 by the end of 2011.

New York will do better. For the past seven years, the TSX has outperformed the S&P 500. This is the year the streak may be broken. American investors have come through a very rough time. In fact, over the five years to the end of 2010, an investment in the S&P 500 returned only 0.7% and that's cumulative, not annual. Many US stocks are trading at bargain basement multiples as a result. As the economy strengthens and confidence returns, that will change. As a result, I think the S&P 500 has the potential to gain 15% this year, finishing around 1,450.

Rate Hikes on Tap
Interest rates will rise. Bank of Canada Governor Mark Carney continues to fret about the dangers inherent in the country's high debt to household income ratio. I believe this will lead to a more aggressive rate stance by the Bank, especially in the second half of the year. Look for the overnight target rate to double, to 2%, in 2011. It's even possible the Federal Reserve Board could finally move off its almost-zero rate position later in the year.

Bonds are dangerous. [Tom Slee explains just how dangerous here—Editor.] To protect yourself, focus on short-term issues that will be less vulnerable to the effect of rate increases. High-yield bonds offer the best potential for capital gains, as long as you can handle the risk. 

Get Ready for $115 Oil
Oil will move through $100. I think oil at $100 a barrel is only a few months away and we will likely see it trading between $110 and $115 by the end of 2011.

Commodities will be firm. We should continue to see strength in key resources in 2011 as the economic recovery continues but it is unlikely to be as dramatic as in 2010.

If the US dollar continues to decline in world currency markets, gold should move through $1,500 by the end of the first quarter. I look for a price in the $1,600 range by year-end. Silver will follow a similar pattern.

The Canadian dollar will hover. The loonie rose 5.2% against the greenback in 2010 and finished the year slightly above parity. A further increase of that magnitude this year would take it to almost US$1.06. While that is possible on a short-term basis, it is probably not sustainable. More likely, the loonie will trade within a couple of cents of parity through most of 2011.

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