TD suggests tough market lies ahead

(November 19, 2004) Investors will have to work a little harder in 2005 if they want to find strong returns, according to economists at TD Bank Financial. A report from the bank, entitled “2005 Investment Outlook: An Economic Perspective,” calls for weaker returns on both equity and bond markets, but sees a limited threat to the overall economy.

“The economic outlook is for moderate growth, subdued inflation and continued gains in corporate profits,” says Craig Alexander, associate vice-president and senior economist, TD Bank Financial Group. “However, this positive economic backdrop may not translate into strong investment returns.”

The report warns of higher interest rates as the Bank of Canada tightens credit, which will benefit short-term money market investments, but will “grind” bonds lower.

“A well-diversified basket of bonds is likely to return 2% to 4.5% in the coming year,” the report says. “A superior performance might be provided by overweighting shorter dated bonds and corporate bonds.”

Meanwhile,equity markets will be struck by global uncertainty, ranging from China reining in its economy, to further softness in the U.S. dollar. Returns between 3% and 6% on the overall market are seen to drive investors into stocks with stable earnings and high dividend payments.

“Markets hate uncertainty and a host of economic and financial risks overshadows the investment prospects for the coming year,” said Alexander, pointing to concerns over China, high energy prices and staving of a U.S. economic meltdown, which could drive the Canadian dollar even higher.

Canadian bonds are expected to outperform their U.S. counterparts, resulting in narrower Canada-U.S. interest rate spreads. Because the Bank of Canada has said the economy is operating near full capacity, the report suggests interest rates will increase in the coming months. The overnight rate is expected to increase from 2.5% to 3.5% by the end of 2005, with cash providing an average return of 2.5% to 3.25%.

“While some may be disheartened by the forecast for low- to mid-single-digit returns in 2005, investors should not lose sight of the forest for the trees,” said Alexander. “Financial plans should be built on the basis of a long-term strategy tailored to an individual’s long-term goals.”

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com