Blurb: What do you do when none of the major investment classes look a great bet?

Stocks, bonds or real estate?
By Peter Diekmeyer o Bankrate.com

Canadians are a fairly conservative lot. If they have extra cash lying around they are likelier to sock it away, than their looser American cousins, who are more ready to take a Florida vacation, buy a new car, or load up on fancier household appliances.

Canadians traditionally save a higher percentage of their disposable income. When they do spend, they prefer assets that store value, rather than disposable items. That said, in recent months the outlook for almost all of Canadians' traditional investment alternatives is increasingly doubtful in the terms short-term.

Low interest rates make fixed income seem unattractive
Financial institutions have been particularly stingy of late. According to recent Bankrate.ca survey, the average yield for a basic checking account is just 0.31 percent among companies queried. Savings accounts do little better, (0.97 percent), as do one year redeemable GICs, (1.64 percent)

And the trend is not good. As can be seen from a bankrate.ca graph of one year non-redeemable GIC rates, yields have fallen from the 2.1 percent range in December of 2004, to just under 2.0 percent today.

(http://www.bankrate.com/can/graphs/graph_trend.asp?product=337&prodtype=D&ad=dep)

According to Clément Gignac, chief economist at National Bank of Canada, the long-term interest rate picture looks even bleaker. Gignac predicts that the U.S. fed funds rate will rise a full two percentage points to 4.5 percent by year-end, from its current 2.5 percent. If that happens, Canadian rates will likely follow.

Interest rate increases rain havoc on fixed income instruments such as Canadian government issued five and ten-year notes. Higher rates reduce the value of existing bonds, because investors can get a better yield by buying new issues.

Those who think that Canadian rates will rise are in a Catch-22 situation. They can't buy long-term bonds because they will lose value if rates rise. But if they invest in checking accounts or GICs, then inflation and taxes will eat away at what little interest they earn.

Stocks have had a good run
The stock market seems hardly more attractive. The S&P TSX has been on a tear of late, jumping from under 6,000 in late 2002, to the 9,600 range this week. That represents a staggering run up of more than 60 percent in just over two years. Real Estate Investment Trusts (REITs), and other investment trusts have also had good runs.

But if history teaches us anything, it's that rapid run-ups in stocks are likely to be followed by prolonged periods of stagnation or declines. The fact that interest rates are likely to rise later this year makes that prospect even more likely.

High interest rates hurt stocks in three ways. They hit corporate profits, because companies have to pay higher interest rates, they make it more expensive for margin borrowers to buy stocks and they make it more attractive for investors to invest in fixed income instruments rather than equities.

The real estate boom
Like the stock market, real estate has been on a bit of a tear in recent years. According to the Canadian Real Estate Association data, --sparked by low interest rates,-- the average price of a Canadian home has shot up from $158,145 in 1999 to $245,149 as at the end of January.2005. That represents an increase of more than 55 percent in five years. House prices have shot up in almost all major markets and asset classes.

But whether that strong growth will continue is an open question. Since much of the run-up in house prices was spurred by low interest rates, which make housing more affordable, if rates continue to rise,-- as Gignac and others expect,-- the real-estate market could move sideways or even drop. Critics counter that Canadian housing price run-ups have been less spectacular than those in other markets such as the U.S., and Great Britain, and that prices still have some upside potential.

Maybe Florida doesn't sound so bad
So what can the average investor do? The cold hard reality is that even though none of the three key investment areas,-- fixed income instruments, stocks or real estate,-- are a slam duck, Canadians have to put their money somewhere. For most families that means that a good part of their wealth will continue to lie in these asset classes.

That said, you can hedge your bets. If you think that interest rates will rise, you can keep at least part of you money in cash accounts or in the form of marketable securities. Even if the interest rate paid on these instruments is low, you can lock in later this year, if the experts are righy and rates do rise.

On the other hand, if you're still not sure, you might want to loosen up a bit and take that Florida vacation. With the recent run up in the Canadian dollar, your trip will cost you a lot less than it would have two years ago.
Just don't forget your sunscreen.

 

 

 

Peter Diekmeyer (http://www.peterdiekmeyer.com/) is a Montreal based business writer.

 

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