Tuesday, December 13, 2011

Turns out I was wrong! (Review of 2011 predictions)

IN late 2010 I made the following predictions:

  1. 2011 growth would be around 3%
  2. 10y T-Bond would price around 2.95/3.30 (because of inflation)
  3. 30y T-Bond would price below 4% but remain above 3.3%
  4. Inflation would be higher than BoC wants but Carney & friends have few options
  5. Oil would remain around $100/bbl
  6. CAD/USD would trade in the 97/101 range.
How did I do?

Turns out not so well on the important stuff, the 10y and the 30y fell dramatically during the year, in fact as an investor the 30y has been a spectacular investment if you consider that yields have dropped from nearly 4% in January 2011 to 2.57%, nearly 1% below my lowest target price.  The same is true for the 10y that fell from 3% in January to 1.75% this morning.

Growth:  the numbers are not all in, but while the first half was a disaster the second half of the year saw an explosion in GDP growth that could take Canada GDP growth rate within spitting distance of my 3% target.  Better yet, growth has been countrywide and relatively equal.  Most will not know, but Canada's car manufacturing capacity is working at capacity -- there is little slack in the economy, and Canadian companies have invested massively over the past 2 years -- allowing for large productivity gains (would be my guess).

Inflation:  That was the easiest to figure out, as long as the global economy didn't implode oil price would be higher than in 2010 (and a massive contributor to inflation this year).  There is no doubt that the BoC has wanted to tighten all year, but there is simply no scope with every other country experiencing serious dislocation (economic & political).  Canadians may not agree with the current government's objectives but one thing for sure is that Canada doesn't suffer from political gridlock!  Anyway inflation is above the BoC's confort zone.

CAD;  The only exchange rate that matters for Canadian is with the USD -- where the bulk of our exports end-up (moreover, the great bulk of Canada's exports are priced in USD), that was the easiest call I could make.  The CAD is clearly overvalued (it should trade in the 92/94 zone).  Earlier in October it seemed that the CAD was heading back into that zone, but it lasted for a few days.  Canada has an effective political system (at all leves), its financial institutions are in excellent shape (at least they have not been tested by a falling property market...yet) and foreigners see Canada (rightly) as a safe haven.

So overall, disappointing, I was of the opinion that because of inflationary pressures and solide economic growth the BoC would raise interest rates (January futures market had a 1% increase in base rate "baked in the cake"), but the BoC's incredibly negative view of the global financial system  forced Carney's hand -- no rate hikes.

My view of the Canadian economy (for investors) was neutral/negative, while I "predicted" stable yield on the sovereign bond market, a weak currency meant that Canada was not a destination of choice -- in fact, the opposite turned out to be the truth!  A foreign investors in Canadian fixed income instruments saw little or no currency fluctuation (at least against the USD) and massive yield drop -- the impact on bond prices has been massive.  You win some you loose some!


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