• David Cockfield

A Look Back – A Look Ahead


2014 had some notable events that will have the potential to impact financial markets in 2015.

Those events included Russia’s dealings with Ukraine, the Syrian war, the rise of ISIS in Iraq, the oil price decline and the Republican electoral majority in the U.S.

In general, financial markets in North America performed well in 2014. In the U.S., after a slow start the Dow was up 9.13% during the year, while the S&P 500 posted a 12.98% gain. In Canada the TSX with income was up 10.55%. Canadian returns were somewhat disappointing with the selloff in the energy sector short circuiting the year-end rally. In the fixed income area interest rates remained low and drifted lower despite predication's of higher rates. From a general market perspective, financial markets during 2014, in contrast to previous years, tended to ignore negative political events both domestic and foreign and focus on positive economic and corporate growth.

Looking ahead to 2015 it is hard to imagine that the unresolved issues outlined in our review of 2014 will not impact investor psychology this year. Russia is now in recession as Western sanctions and low oil prices impact their economy. Putin has boxed himself in by promoting Russian nationalism in his annexation of the Crimea and his actions in eastern Ukraine. Will he become more aggressive? Or accommodate a settlement.

The ongoing war in Syria and the rise of ISIS in Iraq is both a political and economic threat. Should Assad’s weakening government fall, significant military resources will pass to ISIS and thus be available in Iraq. Since Iraq exports some 3.6 million barrels of oil daily a victory in Iraq for ISIS would have an immediate world economic impact. Would the Western world stand aside? Or would western ground troops again be sent to Iraq?

The dramatic fall in oil prices, while negative for the oil industry, is a major positive for the world economy, and particularly for North America. It should be remembered that North Americans are the greatest consumers of energy per capita in the world. It is estimated that the benefits of lower gasoline prices for the U.S.consumers on an annual basis are some $150 billion - Canadian consumers will see$15 billion in benefits. These are likely conservative estimates of true total benefits, as energy costs are embedded in the cost of production for a wide range of goods, services, agriculture and transportation.Forecasters are now predicting that North American consumer price indices will be declining in the upcoming months. To be realistic however, present oil prices in the $50 a barrel range are not sustainable as costs of production in the industry as a whole are well above this level. We expect oil prices to eventually settle in the $70 - $80 barrel range.This still represents a 30% decrease from price levels a year ago.

While lower oil prices are good for most world economies, some producers such as Russia, Western African nations, Iran and Venezuela are facing sharply lower government revenues. The prospect for political instability in these countries is thus increased in 2015. The Canadian energy industry will also be negatively impacted by lower prices and will experience lower rates of growth. However, with first class technology, excellent infrastructure, and good production capabilities, the Canadian energy sector remains competitive on a world wide basis.

The return to a more stable and less fractious political situation in the U.S. is a major hope for 2015. Republican control of the Senate and the House of Representatives should result in a Federal Government budget being passed - the first in years. Approval of the Keystone Pipeline is a Republican priority and a positive outcome is hoped for. With better government leadership, low interest rates, low energy costs and a strong U.S. dollar the U.S. should experience 3% plus GDP growth this year and in 2016. We expect further declines in the Canadian dollar to 80 cents U.S. This will give Canada an additional advantage to participate in the projected stronger growth in the U.S. with improved profit margins on exports.

The fundamental positive for financial markets in 2015 is the expectation that world economic growth in 2015, led by the U.S., will be in the 3% range. With little if any inflation expected, interest rates will remain low. North American equity markets should produce positive returns. Fixed income markets will produce low returns as interest rates move sideways or increase marginally. European equity markets will likely be flat until a stimulus plan is approved and the potential exit of Greece from the EU is decided. While the underlying economic situation is good, the various potential political problems outlined earlier present a threat to financial markets. Market psychology is potentially vulnerable to any of these problems taking a negative turn. In 2015 equity markets could thus be volatile and unpredictable. We continue to emphasize broadly diversified portfolios that not only favour large cap divided paying equities, but nontraditional asset classes such as mortgages, private real estate and private equity, along with absolute return strategies which provide attractive opportunities in this low interest rate environment.

#DavidCockfield

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