Outlook to RRSP Season 2004

Following many years of tortuous volatility, both in the good markets leading up to 2000’s tech collapse, and in the bad ones that ended along with the uncertainty preceding the invasion of Iraq, the markets have had an extraordinary period of stability so far in 2004. Unlike the 8 years prior, this year has seen the markets move lethargically in a narrow range. I don’t think this will last much longer, although I will be happy if we continue to see less volatility than in recent years.

It is a positive indicator for the years ahead that the sharp market recovery of 2003 has largely been digested, without any serious decline. Typically, such a strong market rise would be followed by a modest correction. It is encouraging that this has not been the case. I believe there are just a few large issues to consider in the current market environment, and while there are positives and negatives, the balance I believe favors growth in the markets.

U.S. Elections. Just as we saw in the lead up to the Iraq war, uncertainty can have an effect. In the case of the war, it was mostly evident once the war got underway, unleashing the markets from the uncertainty that had restrained them to that point. Now, I think the uncertainty of the pending election is overshadowing some very good economic news. While the outcome remains so very much up in the air, market participants are often forced to the sidelines. Rather than invest on the basis of a Republican or Democratic win, only to be quickly shown wrong, many investors simply wait for a clearer poll result or the final poll, the election itself. While I do not think the actual result will make a lot of difference, markets will prefer a Bush win.

Currently ahead in the polls, a Bush win seems more likely than Kerry. While this is not necessarily a popular result among Canadians (here Kerry would win Canada by a near 3:1 margin according to surveys), it may prove the best for your portfolio. With either man, I believe that the deficit in the U.S., certainly an area of concern, will receive more attention and begin to be lowered. Both will have to continue a large and expensive presence in the Middle East, and an offensive war on terrorist cells. The differences in their policies will be subtle, and thus of little impact to our portfolios.

Economic Considerations. There are a great many reasons to be optimistic about the economy, around the world, but particularly in North America. Company earnings are higher than they have ever been. 2003 was a record year for profits in the U.S. and each quarter since has seen continued strong growth. 2004 will almost certainly be another record high for profits. Economic growth is off its multi-decade high pace of the third quarter of 2003, but is still moving at what was once considered a pace too high to not cause inflation. Yet inflation is very tame, and has remained so for years. Interest rates are remarkably low, although they have risen slightly off multi-generational lows. After a few small increases in short term rates – widely anticipated ones at that – longer term rates have actually declined again in recent weeks. Unemployment in the U.S. is a hot topic in an election year. All the attention and rhetoric can sometimes mask the important facts. While higher than it has been in the past four years, U.S. unemployment is remarkably low, and now stands a shade under the level it was when Bill Clinton was elected to his second term in office in 1996 – on a platform heralding his achievements in job creation! Productivity, home ownership, housing starts and a number of other important indicators are better by far than 1996. The valuation of stocks – especially when considered relative to other investment alternatives like GICs or bonds – has not been at such an attractive level in many, many years. As long as profits keep rising, it is inevitable that stocks will rise too.

Oil prices are much in the news too, hitting another record high just today. I think that prices are now partly inflated by speculative attention. If this is so, then prices will retreat somewhat. It must also be remembered that oil is priced in US$, a currency which has declined by approximately 20% in the past two years. Were it not for this decline, oil prices would still be $40 per barrel, but not $50. As you may have read over the past year, high demand for oil is also to blame for the higher prices. The economies of the world, and in particular emerging powers such as India and China, are very strong and thus demanding more and more resources to fuel their growth. What I find funny is that you will often read in the same article that high oil prices are putting the world at risk of recession. You cannot have economies so strong that they are pushing up oil prices at the same time as those economies are shrinking in a recession. If oil prices rise too high they will be the cause of a fall in demand and bring prices down, just as is the case with any other commodity. It tends to be only very large, very sudden interruptions of supply that have sharp economic effect. Part of the reason the U.S. Strategic Petroleum Reserve has been nearly filled in the past few years (over 600 million barrels, or nearly a year’s U.S. imports, and growing) is to help insulate the oil market from such a shock. In the meantime, sales of the new Hummer SUV are off dramatically.

With a steady supply of good economic news, I am looking forward to rising markets in the months and years ahead. There is always the risk of catastrophic events, as 9/11 reminded us, but for these risks, new investment alternatives have emerged. Guaranteed principal investments that can still benefit from stock market returns are a consideration for those seeking protection from such catastrophes. I will be speaking with a number of clients about including such investments in their portfolios to reduce their overall risk exposure over the months and years ahead, so that we may better weather any future storm. If these types of investments are of interest and you would like to speak about them right away we can meet to discuss our options.

Alan Cameron

Outlook to RRSP Season 2004

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