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Get Used to It

July 21, 2012 | About:
Gordon Pape

Gordon Pape

17 followers
After the crash of 2008-09, many economists said it would take years for the world economy to recover. It turns out they were right. Now you know why they call it "the dismal science".

We are almost four years removed from the start of the plunge that came close to wiping out the global financial system and things are still in a mess. There have been some victories along the way, of course. We saved the banks (only to have them thank us by manipulating key interest rates). General Motors and Chrysler were pulled back from the brink. Massive stimulus by central banks rescued the world from recession and managed to spark tentative growth in key countries like the U.S.

But the reality is that we continue to pay the price for many years of excess and that is not going to end any time soon. The plain fact is that what we see is what we are going to continue to get for several years to come, so get used to it. In some ways, the 2010s are starting to resemble the 1930s, right down to the devastating drought conditions in the heart of the U.S. bread basket.

The July Monetary Policy Report released last week by the Bank of Canada was yet another indicator that anyone who still hopes for a quick turnaround is dreaming. Under the leadership of Governor Mark Carney, our central bank has gained an influence and respect in the international community that is completely disproportionate to Canada's size and economic clout. When Mr. Carney talks, people listen - very carefully.

What he had to say last week with the release of the Report was not encouraging. In case you missed them, here are some of the key points.

1. The outlook for global growth has weakened since the Bank released its last report in April.

2. In China and other developing markets, the slowdown has been greater than expected.

3. Europe is slipping into recession.

4. Although commodity prices have dropped, they remain "elevated" - not encouraging news for our mining and energy sectors.

5. The Bank cut its growth projections for Canada to 2.1% this year, 2.3% in 2013, and 2.5% in 2014. Even those modest numbers have to be taken with a grain of salt since every recent forecast revision from the Bank has been downward.

6. Canada's exports are expected to remain below their pre-recession peak until at least 2014.

One of the especially disquieting aspects of the Report is its forecast for oil prices going forward. The Bank of Canada does not believe that the current prices are going to hold, given a reduction in demand from major developing countries like China and India. It predicts that by the end of this year, the price for West Texas Intermediate (WTI) crude will be about US$87 a barrel and will stay around that level right through to the end of 2014. Brent North Sea oil, which has been trading at a premium to WTI, will fall from US$109 per barrel in the second quarter of this year to US$94 a barrel by the end of 2014.

Lower oil prices would be good news for consumers and would reduce inflation pressure. But they would squeeze the profits of oil producers and put a brake on new development. On the plus side, at least as far as exporters are concerned, lower oil prices would reduce manufacturing costs and put downward pressure on the loonie.

So what are we as investors to take away from all this? Here are some thoughts.

No rising tide. We are not likely to see a broadly-based bull market any time soon - no rising tide that will lift all boats. There will be opportunities to profit in the markets but you will have to be selective. Some of our recent picks that have been especially strong are Dollarama, Stella-Jones, Walmart, eBay, Linamar, Intact Financial, and Westport Innovations. Notice that not one of these is in the commodities sector.

Oil stocks will lag. We are unlikely to see any big upside move in oil stocks for the next few years. If anything, the pressure will be more to the downside if the Bank of Canada forecast is anywhere near right. Therefore, any investments in the oil patch should focus on low-cost producers (Mart Resources, which is recommended by Ryan Irvine elsewhere in this issue, had production costs of only $10.98 per barrel in the first quarter.) Look especially for companies that offer decent dividends that are sustainable if prices settle in the mid to high $80s.

Mining stocks are vulnerable. Most of the miners, with a few notable exceptions like the potash producers, are going to struggle for the next few years.

The TSX will trail the S&P. Without strength in the oil and mining sectors, the TSX will have a tough time making gains. If you want to invest in an index fund, one based on the S&P 500 will be a better choice.

Bonds still look good. I am sounding like a broken record on this but in the light of the Bank of Canada's latest forecast I have to say it again: maintain a healthy portfolio allocation in bonds, especially high-quality corporate issues. Bonds have outperformed the TSX by a significant margin so far this year. The DEX Universe Bond Index was up 2.79% for 2012 as of the close of trading on July 19. The All Corporate Bond Index was doing even better with a gain of 4.19%. With the Bank of Canada likely to keep interest rates on hold until well into 2013, that pattern should continue.

In summation, we are unlikely to see any dramatic change in the current conditions for the next several months and, if we do, the risks are more to the downside. Plan accordingly.

About the author:

Gordon Pape
GuruFocus - Stock Picks and Market Insight of Gurus

Rating: 3.4/5 (9 votes)

Comments

LwC
LwC - 2 years ago
"It predicts that by the end of this year, the price for West Texas Intermediate (WTI) crude will be about US$87 a barrel and will stay around that level right through to the end of 2014."

Also according to the author, lower oil prices "…would squeeze the profits of oil producers and put a brake on new development."

I'm not sure what to make of comments like this. A certain refinery posted a price on July 20 for WTI at $82.00, which is already less than the price predicted above. So if the above prediction of a higher oil price than is now being paid turns out to be true, than how will it have the effect of "squeezing producers' profits" going forward?

ecotycoon
Ecotycoon premium member - 2 years ago
Great article, really good resume, although I think and I could be wrong, that projecting the previous gain in corporate bond into the future could be risky.

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