I began by making the point that this is not an easy question to answer. There are a lot of countervailing forces at work right now which makes the art of fortune telling even more complex than usual.
Even the Bank of Canada is not sure about what's coming. In his remarks at last week's release of the Monetary Policy Report, new Bank Governor Stephen Poloz said that while the global recovery remains intact, "its near-term dynamic has changed and the composition of growth is now slightly less favourable for Canada."
In response, the Bank removed the language from its rate-setting statement that suggested that interest rate hikes weren't far away. The new position is one of neutrality - the next rate move could be up or down depending on how the economy performs.
The Bank also scaled back its growth projection for 2014 to 2.3% from 2.7% previously, citing "uncertain global and domestic economic conditions (which) are delaying the pick-up in exports and business investment." As a result, the level of economic activity is "lower than the Bank had been expecting".
To put things in perspective, a 2.3% growth rate next year is much better than the lacklustre 1.6% projected for 2013 by both the Bank of Canada and the International Monetary Fund. But it's a long way from being an economic boom. The effects of 2008 are still being felt.
So what does all this portend for 2014? Here's what I think we should expect.
Growth will pick up. However, the expansion won't be anywhere near as robust as had once been hoped. As that happens, unemployment rates should start to fall, albeit modestly, and capital spending will increase. Among the beneficial side effects will be more government revenue, thus cutting the deficit faster. A recent report said that so far this year, Ottawa is about $7 billion ahead of its deficit forecast. The U.S. is in a similar position, in proportionate terms.
Stronger growth will put upward pressure on interest rates. While the Bank of Canada and the Federal Reserve Board will likely continue to keep their target rates at current levels, the effects will be felt in the bond market where government and corporate issues trade. We already had a taste of this when commercial rates jumped in May in response to speculation that the Fed would soon begin to wind down its quantitative easing program. If there's a repeat in 2014, we may see more downward pressure on REITs, preferred shares, etc.
Returns from Toronto and New York will converge. There has been a huge disparity in the returns from the Toronto and New York stock exchanges this year. As of the close of trading on Oct. 25, the S&P/TSX Composite Index was showing a year-to-date gain of 7.8% By contrast, the S&P 500 was up 23.4%. Even that paled compared to Nasdaq, which has gained 30.6% this year on the strength of a tremendous run for tech stocks.
I have been saying for several years that New York was a better place for your money than Toronto. But that could change in 2014. Wall Street might still outperform us but I think the gap will be much less and may disappear entirely.
There are two reasons for this view. First, the U.S. market is coming off a big year. Historically, advances of this magnitude have been followed by a year of consolidation. Second, Canadian stocks for the most part have not experienced the price increases we have seen in the U.S. so there is more room to move higher. Resource stocks, especially, are unlikely to have as terrible a year as in 2013 - the materials sub-index is down 25.5% year-to-date. As long as the global recovery gathers steam, even at a slow pace, commodities prices should gradually firm. My expectation is then both Toronto and New York will post low double-digit gains next year.
Washington deadlock eases. We could experience another budget/debt ceiling crisis in Washington early in the New Year. All this month's agreement did was to kick the can down the road. The fundamental dynamics have not changed: the Tea Party still hates President Obama and remains determined to derail his cherished health care program.
However, polls showed that the Republicans took a ratings beating as a result of the latest round of brinkmanship. With mid-term elections due in the fall, at which the entire House of Representatives and one-third of the Senate seats will be contested, moderate Republicans (yes, there are some) may assert themselves in a bid to ease tensions.
Continued recovery in Europe. Europe is finally out of recession - even Spain reported third-quarter economic growth, albeit a mere 0.1%. That leaves only Italy still in recession among the major European economies. Europe's growth rate remains modest but at least the continent is finally on the plus side of the ledger. We should expect that trend to continue as long as no major crisis emerges
China is a question mark. Many people, me included, thought China would regain some economic momentum this year. It didn't happen and now people wondering if the country's slower growth rate is becoming the new norm. The government has taken steps to attempt to kick-start the economy again but so far we have not seen much effect. China's performance has important implications for us because a rebound would increase demand for commodities, driving prices higher to the benefit of Canadian producers.
Gold should do better. Bullion had terrible year in 2013 and is down about 20% year-to-date. The miners fared even worse with the S&P/TSX Global Gold Index showing a loss of 38% so far. I expect demand for gold to pick up in 2014 as accelerating growth starts to push up the inflation numbers. But the gains could be modest and a recovery to the US$1,600 range, where bullion sat at the start of this year, seems unlikely. Gold should be held mainly as a defense against renewed inflation and currency devaluation.
The bottom line is that equities are the place to be in 2014, especially those with a growth orientation. Bonds and interest-sensitive securities will continue to be under pressure and defensive positions are recommended.