The first thing I would like to do is review some of my forecasts for 2006. I find that I was right in some areas wrong in others but close in most.
I was not bullish enough on the equity markets in North America, expecting the TSX to reach a high of only 12,500 when the high for the year was just over 13,000. I was optimistic that the DOW would be the leader in the US and outperform the other major averages and that proved to be correct, but here again I was not bullish enough expecting the Dow Jones industrials to top out at just over 12,000 when the high for the year was 12,549, I was far too bearish of the technology sector with a forecast that the NASDAQ would only increase marginally to 2300 when in fact this index closed at 2470 seven percent higher than my target.
I was right in calling for high energy and base metal prices, although the strength in some of these commodities surprised me. I was far too bullish on the Canadian dollar relative to the US dollar with a target of 90-92 cents having expected the US to be in recession by now.
I was a little too bearish of the economy in North America generally and that had an impact on my interest rate forecast, calling for rates to be falling during the year. A lot of the interest rate forecasts will actually be seen this year.
In many of the forecasts I am right but maybe a little early. The one surprise which did materialize was the sell off in the income trust sector.
Now for my views on what is likely to develop over the next year.
Canada:
The TSX will continue to perform well over the next 12 months but will not be as robust as over the past 2-3 years. The TSX is more likely to see a high single digit advance reaching a high for the year in the second or third quarter of 14,000.
The TSX will continue to see strength from the commodity sectors such as energy, base and precious metals. The financial services sector will hold up well but will not be a big factor in the over all advance in the Canadian market.
I am expecting interest rates to fall as the economy shows more consistent signs of slowing, the Bank of Canada will lower rates by 0.25% five times in 2007 bringing the Bank rate down from 4.25% to 3.00% by year end.
The rest of the bond market will rally as investors realize that rates are going to decline substantially, the 30 year government of Canada bond yield will decline from the current 4.10% to around 3.25%. The 30 year Zero Coupon (strip bonds) offer an attractive capital gain potential as this happens.
Commodities:
I am expecting the price of crude oil to remain relatively high trading in a range of $55.00 t0 $70.00 a barrel due to ongoing supply disruptions. Natural gas is a little harder to forecast as the price is tied quite closely to weather conditions but if 2007 is a normal year I would expect natural gas to trade back up in to the $8 -$10 range.
In the Base metal market I would expect to see copper trading between $3.00 and $4.00 a pound, zinc in the range of $1.90 to $2.25 a pound and nickel in a range between $14.50 and $16.50 a pound. This should keep the base metal stocks in the forefront of the move higher over the year.
The price of uranium which has been moving steadily higher over the past couple of years will continue to move up and may reach $100.00 a pound as it will remain in short supply.
The precious metals have been moving up recently and this trend is likely to persist and would accelerate if the US dollar weakens as I expect. The price of gold is likely to move back to the recent high of $750.00 an ounce while silver will move through the high set this year and is likely to touch $20.00 an ounce some time in the next year.
The surprise in the commodity markets will be the surge in the grains as the world demands more variety in their foods and as the ethanol craze uses any excess corn that may be available.
US Markets:
In the US the Dow Jones industrials Index had an excellent year up 16% coming in with the best return of all the major indices. The Dow has more exposure to oil producers and this has helped to push the index higher. Going forward the Dow will have a hard time producing double digit returns in 2007. The US economy is showing signs of slowing and this will have a negative impact on earnings growth over the next 12 months. The Dow will still be the leader due to the multi national companies in the index which will see a benefit of a weaker dollar on over seas sales.
My forecast for the Dow is a moderate up move to 13,250 in the first half of the year then a slide back to around 12,000 in the last half of 2007 as recession concerns dominate investor sentiment.
The NASDAQ was up about 10% in 2006 well ahead of my expectations. The recovery of a number of major technology stocks added strength to the NASDAQ over the past six months. The technology sector still seems to be over valued to me and the excess capacity that was created in the late 1990’s has not been fully absorbed. If the economy slips at all and consumers slow down their pace of consumption price discounting in the tech sector will become even more fierce causing losses at many companies.
As the economy slows I expect the technology sector to be hit hard and with that the NASDAQ will lose value. The NASDAQ could move marginally higher in the first couple of months of the year, but after that it looks down hill all the way to the end of the year with the index closing at or below 2175 a decline of at least 10% from the 2006 closing level.
The Federal Reserve will be forced to lower interest rates starting in the first quarter of 2007 as the economic slow down gains momentum. The Fed will bring rates down for the balance of the year with the Fed Funds rate ending the year down 1.5% from the current 5.25% to close the year around 3.75%.
There are a few areas that bear watching any of these would have an impact on these forecasts. The option backdating scandal could easily blow up into a major event as the SEC and other Federal agencies dig deeper into the process. There is a distinct possibility that this could become another Enron style blow up which could have an impact on a wide range of companies, most in the technology sector creating a very negative investor sentiment towards technology companies.
The Middle East remains in turmoil, Iraq, Iran and Israel are all volatile countries there could be any number of surprises develop in the region any of which could cause the price of oil to surge to new all time highs and cause a global economic slowdown as a result.
As the Democrats take control of the house in January they may be in a very aggressive mood on trade and related areas the potential fall out could be a loss of confidence in the US or a heating up of trade disputes either of which will not be good for the global economy.
So as the saying goes “be careful out there”.
