Recession, bear market unlikely in 2008, predicts TD Waterhouse(

Recession, bear market unlikely in 2008, predicts TD Waterhouse

Dec 17, 2007 8:00:00 AM

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    -  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
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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 2007:

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    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.
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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."

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    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.
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