One of the best statements about investing was told to me by former CI fund manager Bill Sterling: "Investing is a probability game, not a certainty game." With this in mind, here are five predictions – where I believe the balance of probabilities lies – for 2014.
U.S. equities outperform the S&P/TSX, again
For the decade starting in 2002, Canadian investors could point and laugh at U.S. markets while the loonie and the TSX rocketed past them. But the tailwinds behind the Canadian economic miracle – the weaker-U.S.-dollar/stronger-commodity-price trend, credit-driven economic expansion in the emerging markets and declining domestic interest rates imported from the U.S. financial crisis – rolled over in 2013.
China's economy wobbles but it doesn't fall down
China's lending and interest rates spiked higher at the end of every quarter in 2013 as the country's banks scrambled to repay investors on dodgy wealth management products.
A report released Monday indicates that local Chinese governments, which are prevented by law from issuing debt directly, got around the rules and raised $3-trillion (U.S.) through off-balance-sheet Special Purpose Vehicles (SPVs). Nomura Global Research estimates that about half of this debt will have to be written off as non-performing. The federal government can afford to bail out investors, but the wanton lending by local governments is likely to be curtailed in the future, threatening China's economic growth.
Canadian materials stocks languish
This prediction arises directly from the first two. Stronger U.S. markets will push the greenback higher and limit upside for commodity prices (which are denominated in U.S. dollars).
Domestic investors will continue to feel the hangover from the extended investment boom in resource sectors. Like the technology boom of the late 1990s, a lot of money piled in to junior mining and energy stocks with the expectation that China's 10 per cent annual GDP growth path would continue forever. A bunch of these investments will drop to zero, or near enough to make little difference to investors, in 2014.
Profit growth for domestic banks will come into question
Canadian banks are too big, too diversified and too protected to really ever seriously stumble. However, the profit outlook, while not terrible, is becoming increasingly murky.
The notoriously-indebted Canadian consumer has already begun borrowing less. The process of actually deleveraging – reducing the amount of household debt – lies ahead, however, and this will limit profit growth for the banks.
Other sources of bank profits, such as corporate and government bond trading and investment banking, are also slowing down.
Markets will be roughly flat, and investors will wonder why their portfolios are underperforming so badly
This prediction is predicated on a change in market leadership. Investor portfolios tend to become overweight in the market sectors that have outperformed over the previous three-to-five year period. In the case of the Canadian market, this includes resources, REITs and other dividend-related sectors.
When sector leadership changes, equity benchmarks tend to tread water, remaining flat. As the sectors that had previously lagged begin to rally, those positive effects are offset by the underperformance of the previous winners. But the investor portfolios that are overweight the old performance leaders fall, because they are underweight the stocks that form the new hot sectors.
These five predictions broadly represent what I expect to happen in the next twelve months. But, per Mr. Sterling, I'm not certain about any of it. Otherwise, I'd hold five massively-leveraged trades that, if they worked, would result in all future posts written on a yacht in the Caribbean (if at all). Keep this thought in mind when watching the seemingly-bulletproof confidence of financial TV pundits in the coming days.
Scott Barlow