Saturday, December 25, 2010

2011 Outlook as guessed by GW


It is yearend so let's see what may lie in store for us in next year's investment universe. Let's start with energy prices. Oil prices are likely to continue going up, but if it shoots up too high it would limit economic growth. The two keep each other in check. When oil prices are too high, economic growth would slow down and that reduces oil demand; too much economic growth would drive the oil price up and slow economic growth. China is trying to control its economic growth and it has tried to do so unsuccessfully for many years. However, the balance between oil prices and economic growth may do the trick.

I see oil prices gradually increase; trading in a $85 to $110 price range with possibly some spikes during the summer driving season. Gas prices will be affected by drilling rig count, economic demand in N. America and the weather. I expect prices in the 4 to $6 dollar range. Also affecting gas demand is electricity generation – gas will become an increasingly more important fuel source for electricity over the coming decade and with the advance of electric cars demand for electricity could easily double in 10 to 20 years. However, over the short term this is not likely to have much influence. Also, consider that creating power generating capacity is something that takes years of planning. In terms of stock market performance, I think oil producing companies will shine. In Canada, the issue will be whether labour costs, land prices and construction prices will escalate even faster than oil prices.

Natural gas companies will remain laggards in the 2011 stock market. However, their profitability may somewhat improve. We still will be in a world of cheap prices for gas companies in 2011; thereafter in 2012 and 2013 prices could rise dramatically though. Consider bargain hunting in 2011 for gas producers or for oil companies with significant gas holdings using profits taken from other sectors– only buy the best managed companies and see them as intermediary to long term holds.
 
Canadian banks will continue buying 'cheap' international assets in their drive to benefit of their 'advantaged position' in the banking world. However, new acquisitions will reduce earnings power due to decreased leverage. Return on equity for Canadian banks will likely go down and so will the banks' lofty P/Es. With limited upside to increase dividends especially when combined with rising interest rates and more acquisitions, banks will be modestly attractive investments for some time to come. They are not likely to crash; instead they will be market performers or laggards. So a diversified portfolio should be underweight in Canadian banks.

The Canadian Dollar will remain strong which will be good for productivity growth but not for exports. Future growth prospects, especially when combined with limited leverage and high energy prices will result in muted stock market performance of the manufacturing sector. However, hi-tech gadget manufacturers like Blackberry's RIM spurned because of the Apple craze, may surprise pleasantly in 2011 contrary to guru sentiment.

The growing world economy and the growing world middle class spells well for agriculture. However, here too the Canadian Dollar may dampen the fun a bit. Don't panic though; previous analyses showed that most of the Canadian Dollar's appreciation was visa vie the U.S. Dollar and a lot less against other currencies. The Chinese Rembini may be loosened up somewhat further to reflect its true value against other currencies, in particular the U.S. Dollar. This may be beneficial to Canadian manufacturing and agriculture. So overall, don't be too afraid of a 'strong' Canadian Dollar. Expect companies such as Potash, Agrium, and food producers or other agricultural exporters to do well.

Real Estate oriented companies should benefit from a gradually improving economy too, especially in Western Canada. Right now, though REITs are not exactly cheap. Gold is likely to peak and possibly even crash. It is overvalued to the point of bubbly.

The real surprise of 2011 will be the good performance of the U.S. economy and that will put gold into the doldrums even further. So next year's investment theme will be to avoid gold; modest growth for Eastern Canadian manufacturing and banking; good performance in the Oil and Gas industry (especially oil). Real estate trusts may outperform because of low interest rates combined with better occupancy in both retail and rental real estate.

The U.S. economy will surprise many. The numbers are ever improving while expectations are low. Hi-tech companies such as Cisco and Microsoft are dirt cheap, maybe their time has come.Have you seen Xbox with Kinetics (kinetically driven computer operating systems as seen in SF movies like Pay Check may not be far off)? Apple may lead in gadgetry and depends on one man (Steve or is it Stephen?); Google is hitting the search engine ceiling, but Microsoft and Cisco are leading to a new way of computer, gaming and TV interfacing – something not recognized in today's stock market. Many of the Dow Jones Industrial valuations don't reflect its companies' exposure to an improving world economy, to an U.S. economy growing 3 to 4% in GDP, nor do they reflect their large cash holdings. This is where the money will be made. GE has turned the corner and will perform with, if not outperform, the market.

Emerging market economies will continue to grow but their stock market expectations are too high. With the unwinding of the European crises and returning stock and bond market confidence in the EU during 2011,stock markets in that part of the world may perform comparatively well– many experts paint the EU's issues too dark – don't forget in total the EU is a larger economy that the U.S., while Greece, Ireland, Iceland and Portugal have always been on the fringe. Europe's real core countries are Germany, England, France and the Benelux.

In terms of real estate, I foresee an excellent year in the West for landlords and modest real estate price increases along with the recovering Alberta economy. Also, this part of the country lagged last year's excellent performance in Eastern Canada and B.C. due to HST fears, Olympics and rising interest anxiety. In 2011 the West Canadian real estate will outperform. Alberta will rise and fall with China's and other BRIC country performance. It may also benefit, along with the Rest of Canada, from the U.S. recovery and improving U.S. consumer confidence. Expect low interest rates that will gradually increase throughout 2011 along with the improving North American economy.

In summary, apart from having a diversified investment portfolio that is low in fixed income (especially medium and long term fixed income), it is time to put your cash to work. Invest in Western Canadian real estate, especially between now and early spring. This may be the end of the low real estate valuation window for Western Canada. Invest in oil and in some gas companies on the stock market. Banks should be underweighted. Overweight the U.S. – Dow Jones Industrials and Hi-tech giants. Reduce cash. I expect Canadian stock market returns in the 10% range; same for Europe and Asia. Best returns will likely be in the U.S. 10 – 15%. I could be wrong, but don't worry - I correct that through frequent weekly, daily and hourly forecasts.

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