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Recession, bear market unlikely in 2008, predicts TD Waterhouse

7 minute read
By TD Bank Group
• Dec. 17, 2007
- Positive factors in U.S. will outweigh negatives and yield high single-digit returns - Canadian equity markets will lag U.S. but still generate single-digit returns - Fixed income will earn more in 2008 than 2007 - Europe will again be best international market TORONTO, Dec. 17 /CNW/ - TD Waterhouse today released its 2008 Investment Outlook, offering insight into future market trends and their impact on investment portfolios. The Outlook predicts that, despite continuing fall-out from the sub-prime lending crisis in 2008, several positive factors in the U.S. economy will more than offset the negatives and will cause the U.S. stock market to rise for its sixth consecutive year. The annual report also examined its 2007 predictions and found that five out of six were accurate. "The biggest question facing investors at the moment is whether the five year-old global bull market will see a sixth year, or whether the sub-prime lending crisis will tip the U.S. into recession and cause a bear market," says Bob Gorman, Chief Portfolio Strategist, TD Waterhouse. "But there has been so much coverage of the sub-prime crisis that we believe it's already embedded in current market prices. Therefore, other strong fundamentals, when combined with the stimulative effect on markets of the presidential cycle, will outweigh the sub-prime impact and keep the economy out of recession territory." Gorman predicts that the following six themes should dominate the markets in 2008: U.S. Market Outlook The U.S. stock market will rise for the sixth consecutive year, with the most likely outcome being high single-digit returns. Positive factors contributing to this outlook include: - An S&P 500 Price:Earnings (P:E) ratio of between 15-16, in line with the historical average and indicating stocks that present fair value. - U.S. stocks that are inexpensive compared with bonds. Their earnings yield (earnings divided by share price) is about 6.25% based on the P:E multiple of 16 cited above, or about 50% higher than the 4.15% yield of a U.S. 10-Year Treasury bond. - An accommodative monetary policy designed to stimulate the economy and help the financial sector. This will bring cuts to the Fed Funds rate and a steepening of the yield curve. - Some downward pressure on the Canadian dollar in 2008, boosting the value of U.S. investments. - The decline of the U.S. dollar has caused a surge in U.S. exports, which has more than offset weakness in the housing industry. - A U.S. presidential election year, which historically brings solid, positive stock market returns. Contraction of the U.S. housing sector has been more than offset by surging U.S. exports. On the negative side, there will be continuing fall-out from the sub-prime mortgage sector, primarily from increased mortgage loan defaults as sub-prime mortgages come due over the next six months and their rates are adjusted upwards. As well, the massive oversupply of new housing stock, which has already caused the median price of a U.S. home to fall by 5.1% in the past year, will keep the U.S. housing market in recession. There will be continuing rotation into large caps in the U.S. market, a theme that was pronounced in 2007. Large cap growth stocks, generally out of favour since the bursting of the tech bubble in 2000, will be particular beneficiaries of this trend. Good examples are high-calibre tech companies like Cisco, Oracle and Microsoft, which are benefiting from pent-up demand for their products, strong balance sheets among their corporate clients and surging U.S. exports. The Canadian equity market, like its American counterpart, should rise for a sixth consecutive year and generate single-digit returns. The impetus in 2008 will not come from commodity prices, as was the case through much of the current bull market. Rather it will come from the continued rotation into less cyclical sectors, exemplified by major insurers like Manulife, Sun Life and Power Financial. Fixed income investors will earn between 4 to 4.5% in 2008 - more than the sub-coupon returns generated in 2007. Slower economic growth should translate into a lack of upward pressure on bond yields. After the widening of corporate bond spreads in 2007, we expect corporates to outperform government bonds in 2008. Europe should once again be the best-performing major international market, generating positive, single-digit returns. This reflects solid earnings and dividend growth along with good valuations. Japan, after a poor year in 2007, will likely post better returns, close to those in Europe. Caution is warranted in the emerging markets in 2008. First, they are no longer cheap and are, as a group, fully priced. Second, monetary policy is tightening in several cases, particularly in China where inflation is an issue. Third, emerging markets are notoriously volatile and could prove vulnerable to the effects of slowing growth. Gorman concludes that, "Overall, we expect financial markets in 2008 to overcome significant, well-documented risks and generate solid returns." 2007 Predictions and Results Here is how TD Waterhouse's six themes for 2007 played out: Prediction No. 1: The U.S. stock market would rise for the fifth year in a row. Outcome: At this point, it seems the U.S. market will have advanced as suggested. However, it will fall slightly short of the low double-digit return forecast and will be below the Canadian market, especially when considering the adverse impact of the strengthening Canadian dollar on foreign investments. Prediction No. 2: U.S. large cap companies would outperform their smaller counterparts in 2007. Outcome: This forecast has proved accurate to date. The large cap Standard & Poors 500 Index (S&P 500) has out-performed the small cap Russell 2000 Index by 644 basis points (6.44%) in 2007 to date. Whether this is borne out for the full year's returns is not yet clear. Also, the share prices of Bank of America and Home Depot were little changed, and Citigroup declined during the year. Prediction No. 3: A) The Canadian stock market would rise for a fifth consecutive year in 2007, recording a single-digit advance. B) We would begin to see a rotation from the cyclical sectors to the less cyclical. C) Canadian stocks would underperform the U.S. market for the first time since 2001. Outcome: A has proven correct. B has proven true in recent months as investors have become more risk-averse. C is too close to call, although the less cyclical U.S. market seems to have better momentum. Prediction No. 4: Bond investors would earn coupon returns of about 4% in 2007. Outcome: We fell short of the forecast. The Scotia Capital Universe recorded a return of slightly better than 3%. Prediction No. 5: There would be a flurry of mergers among energy trusts, reflecting impaired cash flow among many of the weaker, lower calibre trusts. Outcome: This trend was indeed very pronounced, with smaller, natural gas-oriented trusts proving particularly susceptible and being taken out at depressed valuations. We also underlined the importance of holding the highest calibre energy trusts such as Bonavista, Arc and Vermilion. Bonavista and Vermilion outperformed their peers while Arc was in line with the energy trust sub-index. Prediction No. 6: Europe to be the best major international stock market in 2007, reflecting attractive valuations, solid earnings growth and high dividend yields. Japan would not fare as well. Outcome: This has proven accurate, with Europe generating solid returns while Japan has lost some ground. Nonetheless, the Euro slipped versus the Loonie, negating returns for Canadian investors. About TD Bank Financial Group The Toronto-Dominion Bank and its subsidiaries are collectively known as TD Bank Financial Group. TD Bank Financial Group serves more than 14 million customers in four key businesses operating in a number of locations in key financial centres around the globe: Canadian Personal and Commercial Banking, including TD Canada Trust; Wealth Management, including TD Waterhouse and an investment in TD Ameritrade; U.S. Personal and Commercial Banking through TD Banknorth; and Wholesale Banking, including TD Securities. TD Bank Financial Group also ranks among the world's leading on-line financial services firms, with more than 4.5 million on-line customers. TD Bank Financial Group had CDN$422 billion in assets as of October 31, 2007. The Toronto-Dominion Bank trades on the Toronto and New York Stock Exchanges under the symbol "TD", as well as on the Tokyo Stock Exchange. For further information: or to receive a copy of the 2008 Investment Outlook, please contact: Stephen Ledgley, NATIONAL Public Relations, (416) 848-1376, sledgley@national.ca

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