,

Q1 2022 Outlook

Section 1: Q1 2022 Outlook

 

Global Consumer Prices are Approaching their Fastest Increase of the Past Quarter Century

The COVID-19 pandemic has generated unprecedented macroeconomic volatility and its reverberations will be felt for some years to come. 2020’s lockdowns resulted in the largest drop in global GDP in modern history, which was followed by a re-opening bounce producing the strongest recovery in 50 years.i

Setbacks due to the COVID-19 Delta and Omicron variants have been met by higher natural and vaccine-acquired immunity, significantly lower mortality, and new antiviral treatments. This has occurred in an environment of record corporate liquidity and strong fundamentals that have continued to drive capital investment, inventory re-stocking, shareholder return, and merger and acquisitions activity. Global consumer prices are approaching their fastest increase of the past quarter century.

As economies recover, the stimulus that has been provided by policymakers has led to concerns that a rise in inflation is now embedded. Two unique facts about the nature of the recent stimulus led to inflationary potential. The first is that it has combined fiscal stimulus with central bank asset purchases. The second is the large scale of the two interventions.

 

Measuring Inflation and its Impact on the Pandemic Economy

The break¬even inflation rate is recognized as the difference in yield between a nominal Treasury bond and the real yield on a TIPS bond of equal maturity. Historically, this difference has also been considered a market measure of expected inflation.

More recently, following the Great Recession of 2008-2010, the information content of the breakeven inflation rate as a measure of expected inflation has been impaired. Unprecedented Quantitative Easing (QE) has been implemented to increase the money supply and encourage lending and investment, through controlled asset purchases by the Fed and other central banks. The action has resulted in engineered low rates that are intended to stimulate demand and consumer price inflation via the traditional channels. Recently, around the globe, in Switzerland, Germany, the Netherlands, Denmark, and Finland, nominal rates have been negative all the way out to 30 years due to the impact of versions of QE in those countries.ii Evidence has shown that quantitative easing, especially in Europe and Japan, has not resulted in the desired economic outcomes or a rise in consumer price inflation to target levels.

One offshoot of the low rate of inflation in advanced economies over the past two decades has been for policymakers to accept greater risks of overshooting their targets. The Fed and Bank of Japan have made this most explicit by setting an average inflation target and an “overshooting commitment”, while the ECB has said its new mandate may imply a period of inflation being “moderately above target”.iii

The level of real rates that keeps an economy growing in line with potential growth and inflation at target, is defined as the neutral real interest rate or r*.iv This neutral real interest rate has been declining across advanced economies over the past 50 years, driven by factors that have increased retirement savings in an aging population and enabled higher savings rates flowing to the wealthy due to inequality (the wealthy tend to have higher savings rates). This has occurred while there has also been a fall in desired investment, driven by the rising importance of less capital-intensive services and, the slowdown in potential GDP growth across advanced economies.

Before the pandemic, r* was far lower than in the past. We saw this during the Fed’s tightening cycle in 2016-18, when the fed funds rate rose to between 2.25% and 2.5% – implying a peak in real rates of only about 0.4% – was enough to engineer a slowdown in economic growth, led by rate-sensitive sectors like residential investment and durables consumption.v

We have observed that when inflation does not rise above a trigger level, real interest rates will not likely rise as high as they have in the past in order to bring inflation back down. There are three key reasons for this.

First, real equilibrium interest rates are currently close to zero across advanced economies, which is much lower than they were before the Global Financial Crisis.

Second, the structural factors that have prevented inflationary pressures from becoming embedded in the system remain at play, including flexible labor markets, labor-saving technological progress, and globalization (even if it is partly rolled back).

Third, policymakers’ new mandates recognize these factors and are less concerned than in the past to bring inflation down.

In a scenario of inflation rising to 3-4%, real interest rates need to rise to 1%. That would imply increases in nominal policy rates to between 4% and 5% if central banks decide they want to return inflation to 2%. In a “worse” scenario in which the inflation rate rises to 5% or more on a sustained basis, real interest rates may need to rise to 2-3%. This would give rise to nominal rates of somewhere in the region of 7% to 9% – levels not seen since the early 1990s.vi And as higher inflation may become more ingrained, they may need to stay there for longer. This scenario would be likely to cause a more significant global downturn, much higher unemployment and pose a risk to the property sector.

 

Will Inflation be Persistent Post Pandemic?

Potential parallels have been drawn between the current recovery and the so-called “roaring 20s” after the First World War and the Spanish Flu Pandemic. The 1920s was a decade of strong economic growth, with demand fed by loose policy, financial liberalization, and a surge in demand for consumer appliances related to more homes getting electricity. This strong growth was not accompanied by any pick-up in inflation, partly because the 1920s were also notable for their range of productivity-enhancing innovations.

The current environment may be more like the 1960s and early 1970s, when a rise in demand was backed by strong bank lending that led to money growth and to overheating and a rise in inflation. By the mid-1980s, real interest rates in the U.S. were around 4.5% on average in the G7. At the same time, the prevailing level of r* was considered to be about 3%. At that time, real rates were around 150bp above r*.vii

 

The Fed, Employment, and Inflation

The Phillips curve is an economic concept developed by A. W. Phillips stating that inflation and unemployment have a stable and inverse relationship. In spite of the failure of the relationship to hold true in recent years, the Philips Curve remains the primary model through which the Fed understands inflation. The theory claims that with economic growth comes inflation, which in turn should lead to more jobs and less unemployment.

The Fed has a dual mandate by which it aims for full employment as well as price stability, and it now aims to minimize “shortfalls” from its employment goal. The Fed could keep monetary policy loose even if inflation is slightly above target if it judged that it has not reached full employment.

For much of 2021, the Fed was content to view inflation developments as transitory. If post-pandemic dislocations such as further delays in China’s reopening, supply chain issues and labor shortages persist, inflation may become persistent.

In the U.S., the labor market has tightened faster than expected. This is occurring as the Fed’s full employment goal—the last remaining condition for liftoff—is in sight. Support to pricing may now be pivoting to a tightening labor market that is pushing up wages, business costs, and business output prices.

 

Global Balance Sheets and Combined Fiscal and Monetary Stimulus

Has the pandemic shown inflation to be a fiscal phenomenon?

A decade of QE did not cause much inflation. Fiscal stimulus has sent it soaring. While central banks, not governments, are charged with hitting inflation targets, does the experience of the pandemic show that current inflation is fiscal spending induced?

Aggressive fiscal policy stimulus was a key catalyst of the recovery. The rise in fiscal deficits has dwarfed the size of those seen after the global financial crisis. In the U.S., this has resulted in the biggest ever peacetime deficit.viii This was particularly the case in 2021, when cash injections from central banks were at record monthly levels. After consistently dismissing the threat of inflation, the Fed’s “better late than never” pivot on the issue is part of a general shift in global central banking towards less monetary policy stimulus.

In the 2010s, central banks created vast amounts of money through their QE schemes, while governments enacted fiscal austerity. Inflation in the rich world was mostly too low, undershooting central banks’ targets.

Then the pandemic struck and there was plenty more QE. In combination, economic policy stepped up with the $10.8 trillion in fiscal stimulus implemented worldwide, equivalent to 10% of global GDP.ix The result has been high inflation. The tsunami of fiscal stimulus was accompanied by bond-buying of almost equal magnitude: central banks in America, Britain, the Eurozone, and Japan have together bought more than $9trn in assets. The result has been a surge in deposits at commercial banks.

Our view is that this version of fiscal stimulus leads to more spending. In combination with QE, the central bank creates new money with which it buys the bonds that the government has given out. When everything is netted, the government is not giving out bonds. It is giving out cash. Is this version of expanding combined supply proving to be inflationary?

In the U.S., the rich country that has splurged the most, deposits have risen from around $13.5trn in early 2020 to around $18trn today.x Not by coincidence, the U.S. has also had the most inflation. With consumer prices rising at an annual pace of 7.0% in December, the Federal Reserve on December 15th was forced to acknowledge that inflation had become a serious threat.xi

The current approach that combines monetary and fiscal stimulus is unique in history. One way in which fiscal stimulus boosts inflation is by strengthening households’ and firms’ balance-sheets, making them more likely to spend. When the government raises cash from investors, they receive bonds in exchange. The government then hands out the money to households, returning it into circulation. Netting off, it is as if the government has just given out new bonds. Whether those bonds constitute new wealth for the private sector is the subject of a theoretical debate. When the government runs up debts the public could also expect to pay higher taxes in the future—a liability that offsets their newly created assets.

Investors value government debt, especially America’s, for its liquidity, meaning they are willing to hold it at a lower interest rate than other investments—much like the public is willing to accept a low yield on bank deposits. But, while its policy stance will remain accommodative for quite a while, the world’s most powerful central bank is now set to completely stop its asset purchases by the end of the first quarter of 2022. An increasing number of other central banks (not only in the emerging world but also in some advanced economies such as Norway and the U.K.) have already embarked on interest rate hiking cycles.

If money and debt are substitutes, their combined supply can be powerfully inflationary. David Andolfatto of the Federal Reserve Bank of St. Louis wrote in December 2020, “it seems more accurate to view the national debt less as a form of debt and more as a form of money in circulation.” He also warned Americans to “prepare themselves for a temporary burst of inflation” in light of the one-off increase in national debt during the pandemic.xii

 

2022 Global Inflation Outlook

A sustained surge in inflation has not been experienced across advanced economies during the past three decades. As the inflation risk increases in the post-pandemic world, investors have little practical experience of how to position their portfolios during such times. A critical element in the inflation outlook will be the confidence among consumers and investors that inflation will be managed and controlled successfully as we move out of the pandemic environment.

Risk of a demand-induced inflation looks greatest in the U.S. The policy stimulus there has been especially large, fiscal policy remains loose and output is already much closer to its pre-crisis trend than in other countries. There is less chance of strong demand fueling inflation in Japan and the Eurozone, where the economic recovery is likely to remain slower and the relationship between demand and inflation is weaker.

The 2022 global economic recovery is moving forward with limited slack, particularly in the Developed Markets. Less than three years into the expansion, the global output gap is likely to close in early 2023. While December’s 2021’s 7.0% surge in consumer prices is not expected to be sustained, the combination of limited slack, above-potential growth, and gradual monetary policy normalization points to Developed Markets core inflation settling higher than its pre- pandemic norm.

Markets will no longer have liquidity injections to power them through uncharted and choppy economic waters. Investors will have to take a view on the durability and impact of the inflation surge, including the drivers of its eventual demise. For more than a decade, large-scale central bank purchases of assets boosted not just those being bought in markets but also virtually all other assets, including financial and physical (such as housing, art, and other collectibles).

Tighter financial conditions will continue to feed a combination of financial instability and lower private demand. In its extreme, stagflation policies become a lot less effective at a time when markets are dealing with underpriced liquidity, credit, and solvency risk. Inflation would eventually come down in this scenario through a process that leads to a drop in economic activity.

The combination of strong economic growth, aggressive fiscal and monetary stimulus (comparable only to the post-WWII accommodation), pent-up demand, and supply-chain bottlenecks have triggered an inflation pick-up to levels not experienced for decades. We will monitor key inflation indicators and consumer and investor sentiment.

 

U.S. Inflation Hit Another ~40-Year High

U.S. Consumer Price Index: Year-over-Year Change (%)

SOURCES: S&P DOW JONES INDICES, U.S. BUREAU OF LABOUR STATISTICS, BLS DATA AS OF JANUARY 12, 2022.

 

U.S. Inflation Indicators

SOURCE: AMUNDI RESEARCH AS OF DECEMBER 2021. TIPS: TREASURY INFLATION PROTECTED SECURITY.

 

 

Section 2. Four Themes

 

Theme 1: Energy Prices Drive Global Inflation

There are symptoms of dysfunction in global energy markets. Early in 2022, oil prices in the U.S. have hovered above $80 a barrel, their highest level since late 2014. Natural-gas prices in Europe tripled in 2021. Demand for coal has surged. Power cuts in China, coal shortages in India, and spikes in electricity prices across Europe are the collateral damage.

A few years ago, producers of fossil fuels would have responded to such price signals by swiftly ramping up output and investment. In 2014, with crude above $100 a barrel, Royal Dutch Shell, a European supermajor, put more than $30 billion of capital expenditure into upstream oil and gas projects.

Not this time. Climate change has led to unprecedented pressure on oil and gas firms, especially European ones, to shift away from fossil fuels. As part of Shell’s long-term shift towards markets for lower-carbon gas and power, its upstream capital spending this year has shrunk to about $8 billion.xiii

As the pandemic eases, the oil market could reach a point of lacking any spare capacity, according to Goehring & Rozencwajg, a commodity-investing firm.xiv That might be only a temporary state of affairs; Aramco and ADNOC could respond rapidly. But temporarily at least it would push prices of crude sharply higher, adding further strains to economies already suffering from soaring costs of natural gas for homes and energy-intensive activities, from steelmaking and fertilizer production to blowing glass for wine bottles.

 

Theme 2: Labour Shortages Begin to Drive U.S. Inflation

Labour markets have continued to recover as economies have reopened.

There is mounting evidence of labour shortages intensifying across Developed Markets with the most acute shortages in the U.S. and the U.K. Job vacancies have also increased, and are now well above pre-pandemic levels in Australia, the U.S., and U.K. And while the rise in vacancies is good news to the extent that it reflects strong demand for labour as economies recover, it also suggests that firms are finding it hard to fill positions and could lead to some upward pressure on wages.

Unlike in the U.S., the Eurozone labour market has some spare capacity. And in the U.K., the fact that sectors with the most vacancies are those with the highest share of workers previously on furlough, suggests that there should be less labour market friction as those workers seek employment. A rate hike in the back half of 2022 may be confirmed at the next month’s FOMC meeting.

 

Theme 3: China Growth Restrained

China’s relationship with the United States and the global economy is a critical factor that has the potential to dramatically shape economic growth and investment opportunities, not only in China but globally. While China’s economy managed to outperform its peers during the early months of the pandemic, it now faces major challenges over the near term as deleveraging and policy tightening restrain growth.

While the government has made some progress in controlling shadow banking, it is aware of additional work needed to properly address financial stability risks, especially amid mounting bankruptcies, including state-owned enterprises. Ultra-loose lending facilities of earlier years, coupled with large government deficits and borrowing during the pandemic, caused debt to explode. According to the Bank for International Settlements, non-financial sector domestic debt rose from 239% of GDP in 2015 to reach 290% of GDP at the end of 2020, the increase driven in large part by corporations (which includes state-owned enterprises).xv Deleveraging has become a priority. The government is now willing to accept slower but more sustainable growth. Real estate property developers, for instance, are facing more stringent borrowing conditions, and that has already led to a significant slowdown in loan growth in the construction sector.

Over the longer term, the alteration of global value chains in the aftermath of the pandemic, geopolitical tensions with Western democracies, the relationship with Hong Kong and Taiwan, carrying the Belt and Road Initiative to fruition, an aging workforce, and declining productivity all represent serious challenges for China. The central government is hoping to address some of those with the implementation of its five-year plan, a focus on supporting “home grown” domestic demand. U.S. concerns about China’s respect for intellectual property and other international trade laws, as well as concerns about China’s increasingly aggressive foreign policy, have been escalating since Xi Jinping became president in 2012. Viewing China’s recent actions as a response to actions initiated by the Trump administration seems to overlook the larger context.

 

Theme 4: Fed Policy Support for Risky Assets Ends

The Fed has supported keeping “risk-free” rates low, while also continuing to provide direct support to competing risky assets. These purchases are intended to lower long term interest rates and prod investors into investments that would spur growth.

The original policy began on March 23rd, 2020, when the central bank announced that two corporate bond facilities would be established – a Primary Market Corporate Credit Facility (PMCCF) for new bond and loan issuance, and a Secondary Market Corporate Credit Facility (SMCCF) to provide liquidity for outstanding corporate bonds.xvi

The facilities were enhanced on April 9th, 2020. Changes included i) increases in the Treasury’s equity investments, to $50bn for the PMCCF and $25bn for the SMCCF; ii) a broadening of participation to include “fallen angels” that had been investment-grade on March 22nd; iii) a clarification of the maximum leverage ratios of the SPV: 10:1 for investment-grade and 7:1 for sub-investment-grade bonds; and iv) the inclusion of some high-yield bonds in the SMCCF’s purchases of ETFs. Finally, the SMCCF was tweaked again in June 2020. That facility is now also able to purchase in the secondary market eligible corporate bond portfolios that track a broad market index.xvii

In June of 2020, the Fed announced its decision to tweak its policy again, to provide support to the corporate bond market following the outbreak of COVID-19, buying corporate bonds in the secondary market, and thus feeding further gains in the prices of equities.

In November 2021, fed officials laid out a plan to slow their $120 billion in monthly Treasury bond and mortgage-backed security purchases by $15 billion a month starting in November.xviii

 

 

Section 3. Investment Outlook

 

Global Pandemic Leads Us to a Growth Forecast for the Next Twelve Months while we Continue to Closely Monitor the Outlook for Inflation.

SOURCE: FRAME GLOBAL ASSET MANAGEMENT

 

Frame Global Asset Management considers these trends and factors them into our outlook for the economy in our twelve-month forward period. We look back to periods of similar economic behavior and use this information to predict the future behavior of the asset classes that we consider. Our investment process allows us to adapt for non-traditional monetary policy and other exogenous variables.

 

 

Section 4. December 2021 Portfolio Models

One year after the launch of anti-Covid vaccines, financial markets have been willing to move beyond the pandemic while the economy has not. We see this with the disruptions among supply chains, particularity labor and commodity markets. The longest economic expansion in American history – 128 months – has been followed by the shortest recession – 2 months – and has registered the sharpest rebound ever measured. Inflation continues to be fed by supply shortages, labor costs, worker shortages, and consumers, who are responding to the changes imposed by the pandemic. In December, we maintained our twelve-month forecast of Growth (U.S. GDP greater than 2.5%) through the period while we continue to closely monitor the outlook for inflation.

We maintained our Asset Allocation across all models in December. Corporate earnings across all market caps were solid in Q3. U.S. fiscal spending that will fund local governments in the pending infrastructure bill supports our exposure to short-term treasuries and municipal bond exposure in the U.S. We believe that raising rates too early in 2022 during a transitory inflation environment will not occur for risk of causing a recession.

The global economic recovery is moving forward with limited slack. Against the backdrop of an incomplete recovery and a significant buildup of public sector debt, we have lowered our growth recovery expectations while maintaining our outlook to above 2.5% GDP growth in the U.S. over the next twelve-months.

 

Deborah Frame, CFA, MBA

President and Chief Investment Officer

January 14, 2022

 

iTrading Economics. U.S. Market Return. 2020 and 2021.
iiTrading Economics. Nominal Interest Rate by Country.
iiiTrading Economics. ECB Inflation Target. January 7, 2022.
ivBrookings/Hutchins Centre. Neutral Interest Rate. October 2018.
vFederal Reserve. Open Market Operations. 2016 to 2018.
viTrading Economics. Nominal Interest Rate by Country.
viiTrading Economics. Nominal Interest Rate by Country.
viiiTrading Economics. U.S. Budget. December 10, 2021.
ixInternational Monetary Fund. Covid-19 Global Fiscal Response. November 2021.
xInternational Monetary Fund. Covid-19 Global Fiscal Response. November 2021.
xiTrading Economics. U.S. Fed Funds Rate. December 15, 2021.
xiiDavid Andolfatto. Federal Bank of St. Louis. December 2020.
xiiiThe Energy Shock. The Economist. October 16, 2021.
xivThe Energy Shock. The Economist. October 16, 2021.
xvTrading Economics. China Non- Financial Debt. 2020.
xviU.S. Federal Reserve. March 23, 2020.
xviiU.S. Federal Reserve. June 2020.
xviiiiU.S. Federal Reserve. November 2021.

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December 2021

One year after the launch of anti-Covid vaccines, financial markets have been willing to move beyond the pandemic while the economy has not. We see this with the disruptions among supply chains, particularity labor and commodity markets. The longest economic expansion in American history – 128 months – has been followed by the shortest recession – 2 months – and has registered the sharpest rebound ever measured. Inflation continues to be fed by supply shortages, labor costs, worker shortages, and consumers, who are responding to the changes imposed by the pandemic. In December, we maintained our twelve-month forecast of Growth (U.S. GDP greater than 2.5%) through the period while we continue to closely monitor the outlook for inflation.

The Chinese economy expanded 4.9% year-on-year in Q3 2021, down from 7.9% growth in the previous quarter, amid several headwinds including power shortages and supply chain bottlenecks.1 China’s consumer price inflation accelerated to 2.3% in November from 1.5% a month earlier.2 Exports from China increased by 22% to a record high in November.3

The Euro Area economy advanced 2.2% in the three months to September 2021. Household consumption accelerated while government expenditure slowed.4 The British economy advanced 1.3% in Q3, lower than the 5.5% growth rate in Q2.5 The annual inflation rate in the Euro Area increased to 4.9% in November from 4.1% in October. The biggest increase was seen in cost of energy (27.5%).6 The Euro Area seasonally adjusted unemployment rate edged down to 7.3% in October. Amongst the largest Euro Area economies, the highest jobless rates were recorded in Spain (14.5%), Italy (9.4%) and France (7.6%).7

The U.S. economy expanded an annualized 2.1% in Q3 2021. Personal consumption increased, mainly boosted by international travel, transportation services, and healthcare.8 Monthly inflation in the U.S. came in at 6.8% annualized in November. The indexes for gasoline (6.1%), shelter (0.5%), and food (0.7%) were among the larger contributors.9 The U.S. trade deficit with China decreased $3.2 billion to $28.3 billion. The gap with the EU also narrowed $2.1 billion to $16.6 billion but the deficit with Mexico widened $0.8 billion to $9.7 billion.10 The Canadian economy rebounded by 1.3% in Q3, underpinned by household spending and exports as pandemic restrictions were phased out.11 Canada’s headline inflation rate remained at 4.7% in November, amid supply chain issues and low base year effects.12 The unemployment rate in Canada fell to a new pandemic-low of 6.0% in November.13

It was not smooth sailing for U.S. equities in November, as concerns about the Omicron strain coupled with less-than-transitory inflation and accelerated tapering by the Fed upset markets during the last three days of the month. The S&P 500 posted a loss of 0.7%, outperforming the S&P Midcap 400 and the S&P Small Cap 600, which declined 2.9% and 2.3%, respectively. Canadian equities posted moderate losses with the S&P/TSX Composite down 1.6%. The European markets began November positively, but lockdowns and rising COVID caseloads spread across the continent towards the end of the month, before the twin challenges of a new virus strain and soaring core inflation pushed equities firmly into the red. The S&P Europe 350 finished with a loss of 2.5%. Nearly every country represented in the pan-continental benchmark contributed to the declines, except Switzerland. The S&P U.K. (GBP) was down 1.9%. The broad-based S&P Pan Asia BMI was down 3.8%. Most Asian regional fixed income indices advanced this month, led by the S&P/ASX Australian Government Bond Index, which gained 3% as investors steered towards the relative safety of government securities. Commodities fell heavily, led by a 20% decline in S&P GSCI Crude Oil on the back of fears that new restrictions on global travel may sap demand.

In December, we maintained our Asset Allocation across all models. Corporate earnings across all market caps were solid in Q3. U.S. fiscal spending that will fund local governments in the pending infrastructure bill supports our exposure to short-term treasuries and municipal bond exposure in the U.S. We believe that raising rates too early in 2022 during a transitory inflation environment will not occur for risk of causing a recession.

The global economic recovery is moving forward with limited slack. Against the backdrop of an incomplete recovery and a significant buildup of public sector debt, we have lowered our growth recovery expectations while maintaining our outlook to above 2.5% GDP growth in the U.S. over the next twelve-months. The changing picture of the economy comes with structural challenges to some sectors but eventually expects to lead to improved liquidity, healthy consumer balance sheets, and a healing labor market. Our approach to portfolio management is nimble, opportunistic, and deliberate in identifying asset classes that are best placed to generate returns in a new world order. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame, President and CIO

 

1 Trading Economics. China GDP Growth. October 18, 2021.

2 Trading Economics. China Inflation. December 9, 2021.

3 Trading Economics. China Exports. December 9, 2021.

4 Trading Economics. Europe GDP. December 7, 2021.

5 Trading Economics. U.K. GDP. November 11, 2021.

6 Trading Economics. Europe Inflation. December 17, 2021.

7 Trading Economics. Europe Unemployment. December 2, 2021.

8 Trading Economics. U.S. GDP. November 24, 2021.

9 Trading Economics. U.S. Inflation. December 10, 2021.

10 Trading Economics. U.S. Trade. December 7, 2021.

11 Trading Economics. Canada GDP. November 30, 2021.

12 Trading Economics. Canada Inflation. December 15, 2021.

13 Trading Economics. Canada Unemployment. December 12, 2021.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. November 30, 2021. Index performance is based on total returns and expressed in the local currency of the index.

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November 2021

The demand recovery following 2020’s historic pandemic recession has been concentrated in goods and has pushed supply chains to their limits, extending delivery times to records and boosting prices and volatility in growth and inflation. Supply shortages are raising current inflation, while secular forces that alter the balance of supply and demand and sustain high inflation are also in play. Global growth is tilting in a reflationary direction as a result of the interaction among policy preferences, the recurring waves of the pandemic, and underlying structural change. In November we maintained our twelve-month forward forecast of Growth (U.S. GDP greater than 2.5%) through the period but we are closely monitoring the outlook for inflation.

In contrast to growth elsewhere, China’s current policy is focused on deleveraging, de-carbonization, and a reduction in income inequality. Actions to deliver long-term gains come at the expense of weaker near-term growth. Significant overhangs exist in China’s real estate sector and corporate balance sheets. The Chinese economy grew by a seasonally adjusted 0.2% in the three months to September 2021.1 China’s annual inflation rate accelerated sharply to 1.5% in October 2021 from 0.7% a month earlier.2 China’s surveyed urban unemployment stood at 4.9% in October 2021, unchanged from the previous month, which was the lowest level since December 2018.3

The Euro Area economy advanced 2.2% in the three months to September 30 2021, following 2.1% growth in the previous period. The economy continued to recover from the coronavirus hit with Austria (3.3%), France (3%) and Portugal (2.9%) recording the biggest expansions.4 The British economy advanced 1.3% in Q3 2021, lower than 5.5% in Q2.5 Annual inflation in the Euro Area jumped to 4.1% in October from 3.4% in September.6 This was the highest reading since July of 2008, as the bloc battled surging energy costs due to supply shortages. The annual inflation rate in the U.K. edged down to 3.1% in September from a 9-year high of 3.2% in August. The Euro Area seasonally adjusted unemployment rate edged down to 7.4%.7

As expected, the Fed announced that it will reduce the pace of its asset purchases beginning this month. While manufacturing supply constraints and U.S. labor market dislocations can be linked to pandemic dynamics, the slow supply improvement in recent months raises concerns that global slack is less than previously assumed. The American economy expanded by an annualized 2% in Q3 2021, slowing sharply from 6.7% in Q2.8 This is the weakest quarter of pandemic recovery, as government stimulus declined while a surge in COVID-19 cases and global supply constraints weighed on consumption and production. The annual inflation rate in the U.S. surged to 6.2% in October of 2021, the highest since November of 1990. Upward pressure was broad-based, with energy costs recording the biggest gain (30% vs 24.8% in September).9 The U.S. unemployment rate fell to 4.6% in October 2021, the lowest since March 2020.10 The annual inflation rate in Canada went up to 4.4% in September of 2021 from 4.1% in August.11 The unemployment rate in Canada declined for the fifth straight month to 6.7% in October of 2021 from 6.9% in September.12

Despite lingering inflation concerns, U.S. equities recovered strongly in October, thanks to robust corporate earnings. The S&P 500 posted a gain of 7.0%, outperforming mid and small caps, as the S&P MidCap 400 and the S&P SmallCap 600 rose 5.9% and 3.4%, respectively. Canadian equities posted strong gains in October, with the S&P/TSX Composite up 5.0%. The S&P Europe 350 strengthened 4.7% in October. The U.K. and Switzerland were the top contributors, adding 1% each to the large-cap European benchmark’s performance. The large cap S&P Southeast Asia 40 and S&P Asia 50 outperformed, adding 5.1% and 2.6%, respectively. Commodities run continued in October with the main S&P GSCI Index gaining 5.8%, as S&P GSCI Crude Oil and S&P GCI Silver jumped 12.2% and 8.6%, respectively.

In November, we eliminated our gold exposure and replaced it with exposure to U.S. small caps across all portfolio models. Corporate earnings across all market caps are solid in the third quarter. U.S. fiscal spending that will fund local governments in the pending infrastructure bill supports our exposure to short-term treasuries and municipal bond exposure in the U.S.

The global economic recovery is moving forward with limited slack. Against the backdrop of an incomplete recovery and a significant buildup of public sector debt, we have lowered our growth recovery expectations while maintaining our outlook to above 2.5% GDP growth in the U.S. over the next twelve-month period. The changing picture of the economy comes with structural challenges to some sectors but eventually leads to improved liquidity, healthy consumer balance sheets, and a healing labor market. Our approach to portfolio management is nimble, opportunistic, and deliberate in identifying asset classes that are best placed to generate returns in a new world order. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame, President and CIO

 

1 Trading Economics. China GDP Growth. October 18, 2021.

2 Trading Economics. China Inflation. November 10, 2021.

3 Trading Economics. China Unemployment. November 10, 2021.

4 Trading Economics. Europe GDP Growth. November 16, 2021.

5 Trading Economics. U.K. GDP Growth. November 11, 2021.

6 Trading Economics. Europe Inflation. October 29, 2021.

7 Trading Economics. Europe Unemployment. November 3, 2021.

8 Trading Economics. U.S. GDP Growth. October 28, 2021.

9 Trading Economics. U.S. Inflation. November 10, 2021.

10 Trading Economics. U.S. Unemployment. November 5, 2021.

11 Trading Economics. Canada Inflation. October 20, 2021.

12 Trading Economics. Canada Unemployment. November 5, 2021.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. October 31, 2021. Index performance is based on total returns and expressed in the local currency of the index.

 

 

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October 2021

There has been mounting evidence that the pace of the global recovery has slowed. In many economies, it reflects increased consumer caution about high virus cases and shortages limiting how fast economies can grow. The shortage of semiconductors and the current logjam that is taking place at ports along the west coast of the U.S. has had a big impact on the recovery in the U.S. and their trading partners. The root of the issue boils down to the pandemic disrupting the “traditional” flow of activity — causing a supply and demand imbalance. The most likely outcome is a weakening macro backdrop that will weigh on the longer-end of the yield curve. In September we maintained our twelve-month forward forecast of Growth (U.S. GDP greater than 2.5%) through the period.

The Chinese economy expanded 4.9% year-on-year in the third quarter of 2021, easing sharply from a 7.9% growth in the previous period.1 It was the slowest pace of expansion since the third quarter last year. China’s corporate debt has risen to US$27 trillion, nearly one third of the world’s total corporate debt and 159% of China’s GDP. The construction and engineering sectors (around 45% of the debt) could trigger contagion effects on the global economy.2 The European economy expanded 2.2% in the second quarter of 2021 while the British economy expanded 5.5%.3 The Eurozone annual inflation rate was confirmed at 3.4% in September 2021, the highest rate since before the global financial crisis in September 2008. Energy prices were responsible for almost half of the overall year-on-year inflation reading, rising by 17.6% in September after a 15.4% advance in August.4 Unemployment in Europe held at 7.5% while in the U.K. it was 4.5% in August, the last reported month.5

The final U.S. Q2 GDP growth rate came in at 6.7%. The annual inflation rate in the U.S. edged up to a 13-year high of 5.4% in September from 5.3% in August.6 The U.S. unemployment rate dropped to 4.8% in September 2021, from 5.2% in the previous month. It was the lowest rate since March 2020, as many people left the labor force and the negative effects of Hurricane Ida and the Delta variant’s summer spike started to fade. The jobless rate remained well above the pre-crisis level of about 3.5% due to ongoing labor shortages.7  The Canadian economy unexpectedly shrank 0.3% in Q2 2021, ending three straight quarters of expansion mostly due to a decline in home resale activities and exports.8 The annual inflation rate in Canada went up to 4.4% in September of 2021 from 4.1% in August.9 The unemployment rate in Canada declined for the fourth straight month to 6.9% in September of 2021 from 7.1% in August.10

Mounting fears of inflation, an ongoing Congressional budget impasse, and anticipation of a reduction in Fed liquidity provisions all weighed on U.S. equities in September. For the third quarter, the S&P 500 posted a gain of 0.6%, while the S&P MidCap 400 and the S&P SmallCap 600 fell 1.8% and 2.8%, respectively. Despite losses in September of 2.2%, Canadian equities managed to post slight gains in Q3, with the S&P/TSX Composite up 0.2%. The blue-chip S&P Europe 350 managed a 0.9% gain for the third quarter after declining 2.9% in September. U.K. equities bucked the trend, escaping September’s downturn and rising 2.1% in Q3. The Netherlands had the largest contribution (48bps) to the benchmark while Germany hurt the composite due to an uncertain outcome in government elections at the end of the quarter. The broad-based S&P Pan Asia BMI shed 1.4% in September, leaving it with a loss of 3.0% for the quarter. Japan was the top-performing Asian index in September, with the S&P/TOPIX 150 up 4.7% for the month. Hong Kong and Korea lagged, as an ongoing regulatory crackdown in China and Evergrande’s widely publicized troubles soured investors.

In October we maintained our asset allocation for all portfolio models. The added exposure to Canadian equities in September worked well as the Canadian market, led by higher energy prices, experienced a strong month. U.S. fiscal spending that will fund local governments in the pending infrastructure bill supports our exposure to short-term treasuries and municipal bond exposure in the U.S. We continue to include gold in the asset allocation as a portfolio stabilizer during volatile equity markets.

Our outlook hinges on whether the sources of recent disappointment are transitory amid several headwinds including power shortages, supply chain bottlenecks, a persistent property bubble in China, and COVID-19 outbreaks. Shortages of workers in many economies are also weighing on the growth for the rest of the year. The changing picture of the economy comes with structural changes that will challenge some sectors while at the same time, the reopening is expected to lead to improved liquidity, healthy consumer balance sheets, and a healing labor market. Our approach to portfolio management is nimble, opportunistic, and deliberate in identifying asset classes that are best placed to generate returns in a new world order. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame, President and CIO

 

1 Trading Economics. China GDP. October 18, 2021.

2 S&P DJ. “Can China Escape Its Corporate Debt Trap?”. October 19, 2021.

3 Trading Economics. Europe GDP. September 7, 2021.

4 Trading Economics. Europe Inflation Rate. October 20, 2021.

5 Trading Economics. Europe Unemployment Rate. September 30, 2021.

6 Trading Economics. U.S. Inflation Rate. October 13, 2021.

7 Trading Economics. U.S. Unemployment Rate. October 8, 2021.

8 Trading Economics. Canada GDP. August 31, 2021.

9 Trading Economics. Canada Inflation Rate. October 20, 2021.

10 Trading Economics. Canada Unemployment Rate. October 8, 2021.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. September 30, 2021. Index performance is based on total returns and expressed in the local currency of the index.

 

 

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September 2021

Market volatility returned in September as China’s Evergrande debt crisis, the global prospect for higher taxes, U.S. debt ceiling uncertainty, and upcoming tapering by the Federal Reserve elevated risk. With these events considered, our outlook continues to expect the global recovery to continue. In September we maintained our twelve-month forward forecast of Growth (U.S. GDP greater than 2.5%) through the period.

The Chinese economy advanced 7.9% year-on-year in the second quarter of 2021, slowing sharply from a record 18.3% growth in Q1.1 A slowdown in factory activity, higher raw material costs, and new COVID-19 outbreaks in some regions weighed on the recovery momentum. China’s jobless rate of the population aged 16-24 fell to 15.3% from 16.2% in July.2

Eurozone quarterly economic growth was revised higher to 2.2% in the second quarter of 2021, a rebound following two consecutive periods of contraction, helped by the rapid pace of COVID-19 vaccinations. The Eurozone annual inflation rate was confirmed at 3.0% in August, well above the European Central Bank’s target of 2.0%.3 The unemployment rate in the Euro Area edged down to 7.6% in July 2021 from an upwardly revised 7.8% in June. Spain (14.3%) and Greece (14.6%) remained the two EU countries with the highest unemployment rate.4

The U.S. economy advanced an annualized 6.6% in the second quarter.5  The annual inflation rate eased to 5.3% in August from a 13 year high of 5.4% in July. A slowdown was seen in the cost of used cars, trucks, and transportation services while inflation was steady for shelter and apparel.6 Core inflation in the U.S. is on track to exceed 2% in 2021, fulfilling one of the conditions for raising interest rates. At the September Federal Open Market Committee meeting, the central bank indicated that it could begin tapering as soon as November, noting that the “liftoff” for rate hikes would likely not commence until after the taper process is complete. The U.S. unemployment rate dropped to 5.2% in August, the lowest level since March 2020, despite reports of labor supply shortages and concerns over the lingering threat of the COVID-19 resurgence.7 The Canadian economy shrank 0.3% in the second quarter 2021, ending three consecutive quarters of expansion. International supply chain disruptions have constrained imports of parts mostly for the auto sector and led to a decrease in exports. On a positive note, business inventories, government expenditure, business investment in machinery and equipment, and investment in new home construction and renovation were all higher.8 The unemployment rate in Canada fell for the third straight month to 7.1% in August of 2021 from 7.5% in July.9 The annual inflation rate in Canada accelerated to 4.1% in August from 3.7% in July. It was the highest inflation rate since March of 2003.10

In the U.S., the S&P 500 posted a gain of 3.04% in August, as the Fed’s dovish tone, combined with strong earnings reports, helped the market. While mega-caps led, mid and small-caps also posted gains, with the S&P Mid-Cap 400 and the S&P Small Cap 600 up 2.0% and 2.02%, respectively. U.S. fixed income performance was mostly negative. Canadian equities posted gains in August, with the S&P/TSX Composite up 1.6%. The S&P Europe 350 added 2.1% in August, for a seventh consecutive month of increases. The Netherlands accounted for nearly a third of the European benchmark’s return. Asian equities gained in August, with the S&P Pan Asia BMI up 2.5%. India was the top performing country.  Hong Kong and Korea lagged, as foreign investors redirected flows into Indian and other emerging market equities as a result of a regulatory crackdown in China. Globally, commodities posted losses, driven by weakness in Energy.

In September, we adjusted our asset allocation for all portfolio models. In the Conservative and Moderate Growth models we added exposure to Canadian equities while reducing exposure to Gold. In the Growth and Aggressive Growth models, we sold the entire exposure to Australian equities and replaced it with exposure to Canadian equities. This change was driven by the improving outlook for Canada as it emerges from the pandemic. Fiscal spending that funds local governments supports our exposure to treasuries and municipal bond exposure in the U.S. We continue to include gold in the asset allocation as a portfolio stabilizer during volatile equity markets.

Our outlook hinges on whether the sources of recent disappointment are transitory. The rapid spread of the coronavirus delta variant, supply-chain disruptions, the shortage of workers, and a cooling housing market are seen to be limiting full recovery potential currently. The changing picture of the economy comes with structural changes that will challenge some sectors while at the same time, the reopening is expected to lead to improved liquidity, healthy consumer balance sheets, and a healing labor market. Our approach to portfolio management is nimble, opportunistic, and deliberate in identifying asset classes that are best placed to generate returns in a new world order. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame, President and CIO

 

1 Trading Economics. China GDP, National Bureau of Statistics of China. July 15, 2021.

2 Trading Economics. China Unemployment. September 9, 2021.

3 Trading Economics. Europe Inflation. September 17, 2021.

4 Trading Economics. Europe Unemployment. September 17, 2021.

5 Trading Economics. U.S. GDP, U.S. Bureau of Economic Analysis. August 26, 2021.

6 Trading Economics. U.S. Inflation. September 14, 2021.

7 Trading Economics. U.S. Unemployment. September 3, 2021.

8 Trading Economics. Canada GDP. August 31, 2021.

9 Trading Economics. Canada Unemployment. September 10, 2021.

10 Trading Economics. Canada Inflation. September 9, 2021.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. August 31, 2021. Index performance is based on total returns and expressed in the local currency of the index.

 

 

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August 2021

At the start of the year, inflation was widely expected to pick up as the base effects of a collapse in energy prices in the spring of 2020 began to show up in year-on-year inflation readings. The magnitude of the increase now appears to extend beyond those effects due to the ongoing rise in commodity prices, persistent and more severe bottlenecks in manufacturing supply chains, and jumps in the price of certain items of the Consumer Price Index, such as used cars, travel, and accommodation. Looking ahead, most of these inflationary impulses are likely to fade over the next twelve months as supply bottlenecks ease. In addition, there is a sizeable pool of unemployed workers, unlike in most previous inflationary episodes, even if there is no precedent for the kind of shock the U.S. and other economies have undergone over the past 18 months.

In mid-July, our growth concerns were largely driven by the delta variant. Fortunately, the delta wave is not generating a high level of hospitalizations or fatalities to force the reintroduction of lockdowns in major Western economies. Currently, Chinese growth and regulatory risks and Fed tapering concerns in addition to retail sales contractions in the U.S., China, and the U.K. are our primary risk concerns. On the geopolitical front, the chaotic U.S. withdrawal from Afghanistan is ongoing. In August, we updated our twelve-month forecast to reflect our view that Stagnation is no longer a risk. Our current twelve-month outlook is for Growth (U.S. GDP greater than 2.5%) through the period.

China has centralized political power to move rapidly on reforms, creating new structural problems while antagonizing foreign nations. The Chinese economy advanced 7.9% year-on-year in Q2 of 2021. A slowdown in factory activity, higher raw material costs, and new COVID-19 outbreaks in some regions all weighed on the recovery momentum.1 The Eurozone quarterly economic growth was confirmed at 2.0% in 2021 Q2, following two consecutive periods of contraction. Among the bloc’s largest economies, Germany, France, Spain, and the Netherlands returned to growth.2 The Euro Area seasonally adjusted unemployment rate edged down to 7.7% in June. The U.K. unemployment rate fell to 4.7% in Q2 although the rate remained 0.8 percentage points higher than before the pandemic.3

The U.S. economy advanced an annualized 6.5% in Q2 2021. Personal consumption expenditures grew 11.8% as vaccinated Americans traveled and engaged in activities that were restricted before.4 U.S. CPI stood at 5.4% in July 2021, unchanged from previous month’s 13-year high.5 The U.S. unemployment rate was 5.4% in July. These levels remain well above their levels prior to the coronavirus pandemic (3.5% in February 2020).6 Fed officials expressed a range of views on the appropriate pace of tapering asset purchases, but most noted that it could be appropriate to start reducing the pace of asset purchases this year, provided that the economy was to evolve broadly. The Fed left the target range for its federal funds rate unchanged at 0-0.25% in July.7 In Canada, the annual inflation rate increased to 3.7% in July of 2021 from 3.1% in June.8 The unemployment rate fell to 7.5% in July from 7.8% in June.9 The Bank of Canada left its key overnight rate unchanged at 0.25% on July 14th but adjusted the quantitative easing program to a target pace of $2bn from $3bn per week.

U.S. equities generally ended  July in positive territory, with the S&P 500 posting a gain of 2.4%. S&P MidCap 400 posted slight gains of 0.4%, while the S&P SmallCap 600 fell 2.4%. The S&P/TSX Composite was up 0.8%. Asian equities declined, with the S&P Pan Asia BMI down 4.1%, led by heavy losses in China, as a result of Beijing’s clampdown on tech companies. The S&P Europe 350 continued to climb, marking new all-time highs, as it rode to a total return of 1.8%. With the U.K. lagging this month, Switzerland, France, and the Netherlands lead; contributing more than half of S&P Europe 350’s returns.

In August, we maintained our asset allocation from July for all portfolio models. The U.S. economy is slowly recovering. Fiscal spending that funds local governments supports our exposure to treasuries and municipal bond exposure in the U.S. The yield curve flattened in July. We continue to include gold in the asset allocation as a portfolio stabilizer during volatile equity markets.

Our outlook hinges on whether the sources of recent disappointment related to the Delta wave, China policy, and global supply constraints are transitory.  Concerns remain about the global spread of the pandemic and an unbalanced recovery domestically. The changing picture of the economy comes with structural changes that will challenge some sectors. The economic reopening and the global stimulus that is underway will lead to improved household liquidity, healthy consumer balance sheets, and a healing labor market. Our approach to portfolio management is nimble, opportunistic, and deliberate in identifying asset classes that are best placed to generate returns in a new world order. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame, President and CIO

 

1 Trading Economics. China GDP, National Bureau of Statistics of China. July 15, 2021.

2 Trading Economics. Europe GDP. August 17, 2021.

3 Trading Economics. Europe Unemployment, Office for National Statistics. July 30, 2021.

4 Trading Economics. U.S. GDP, U.S. Bureau of Economic Analysis. August 26, 2021.

5 Trading Economics. U.S. Inflation,  U.S. Bureau of Labor Statistics. August 11, 2021.

6 Trading Economics. U.S. Unemployment, U.S. Bureau of Labor Statistics. August 6, 2021.

7 Trading Economics. U.S. Federal Reserve. July 28, 2021.

8 Trading Economics. Canada Inflation, Statistics Canada. August 18, 2021.

9 Trading Economics. Canada Unemployment. August 6, 2021.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. July 30, 2021. Index performance is based on total returns and expressed in the local currency of the index.

 

 

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July 2021

The COVID-19 pandemic appears to be less dramatic and lethal than some historic plagues and vaccinations will limit impact. Unfortunately, after substantial progress, the world faces a new enemy in the Delta variant. This highly contagious form of the virus devastated the subcontinent in spring and has now spread to almost 100 countries including the U.K., Spain, Russia, South Africa, Indonesia, Thailand, Bangladesh, and Malaysia where it has sparked a resurgence of cases. Signs of accelerating inflation around the world may be transitory or more lasting. How central banks respond to price pressures during a post-Covid economic rebound will determine inflation’s impact. We have maintained our economic outlook of three months of Growth followed by Stagnation for the remainder of our twelve-month forecast horizon.

The Chinese economy grew by a seasonally adjusted 1.3% in Q2 2021.1 China’s economy sustained a steady recovery, with production and demand picking up, employment and prices remaining stable, market expectations improving, and major macro indicators staying within a reasonable range. In Europe, the improving health situation and ensuing continued easing of virus containment measures are putting the economies and tourism back in motion, which should also benefit from the new EU Digital COVID Certificate.2 These factors are expected to outweigh the temporary production input shortages and rising costs hitting parts of the manufacturing sector.

The U.S. economy continues to recover, following a Q1 expansion of 6.4% annualized.3 Household spending is likely to be the main driver, with business investment also contributing to growth. Residential investment is expected to slow from its recent pace, and the labour market is expected to take more time for the upside effects of reopening to be fully absorbed. The Fed is expected to keep its monetary policy extremely accommodative in the coming months.

The IMF has predicted that U.S. GDP will rise above the level expected before the pandemic, at least temporarily. Forecasts are driven by four current positive factors. 1) Business finances are healthy. Most recessions in the past had financial causes. The current recession was met with firm government action that bolstered the financial system and most businesses’ balance sheets. That leaves businesses ready, willing, and able to spend once they get the signal that they can do so safely. 2) Households, particularly higher income, are sitting on savings of about US$2.8 trillion more than in Q1 than under “normal” circumstances before the pandemic. Since consumers in aggregate didn’t take on more debt, balance sheets are healthy. 3) The pandemic accelerated productivity trends, particularly telecommuting and e-commerce, that were already underway, forcing managers and consumers to adopt new technology with little notice. 4) Government spending is expected to continue to support growth. The pandemic relief bills were instrumental in keeping the economy poised for growth once vaccinations are widespread—even if not every expenditure was an effective use of money.4

The Canadian economy has already recovered nearly 80% of the jobs lost during the Covid-19 induced recession.5 The rollout of vaccines got off to a slow start in Canada but picked up in the spring when availability improved. The increase in vaccinations has enabled provinces to loosen restrictions. Jobs for lower income Canadians remain well below pre-pandemic levels.

U.S. equities ended Q2 strong, with the S&P 500 posting a gain of 8.6%, despite inflation concerns and uncertainty over the future course of the Fed’s stimulus efforts. In a reversal from Q1, the S&P MidCap 400 and S&P SmallCap 600 underperformed, up 3.6% and 4.5%, respectively. Canadian equities posted gains, with the S&P/TSX Composite up 8.5%. After reaching a new all-time high at the start of the quarter, the S&P Europe 350 continued to set new records through Q2. The broad-based index finished with a 1.7% total return for the month, making it 6.7% for Q2, and 16% YTD. Switzerland, France, and the United Kingdom made the biggest positive contributions over the quarter, with each adding more than 1% to the S&P Europe 350’s returns. Asian equities rose in Q2, with the S&P Pan Asia BMI up 3.2%.  All Asian single-country S&P indices posted gains.

In July, we maintained our asset allocation from June for all portfolio models. The U.S. economy appears to be losing momentum again as the delta variant is spreading through the primarily unvaccinated population in America. Fiscal spending that funds local governments supports our exposure to treasuries and municipal bond exposure in the U.S. The yield curve flattened in June, and Treasuries have outperformed corporates and high yield. We continue to include gold in the asset allocation as a portfolio stabilizer during volatile equity markets.

The economic reopening and the global stimulus that is underway will lead to improved household liquidity, healthy consumer balance sheets, and a healing labor market. Concerns remain about the global spread of the pandemic and an unbalanced recovery domestically. The changing picture of the economy comes with structural changes that will challenge some sectors. Investment in structures—especially office and retail buildings—is likely to lag while businesses are expected to double down on technology investment. Growing e-commerce will mean growing demand for light vehicles and medium-weight trucks for delivery services along with a demand for drivers, gasoline, and related products. Our approach to portfolio management is nimble, opportunistic, and deliberate in identifying asset classes that are best placed to generate returns in a new world order. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame, President and CIO

 

1 Trading Economics. China GDP Growth Rate, National Bureau of Statistics of China. July 15, 2021.

2 European Economic Commission. July 7, 2021.

3 Trading Economics. U.S. GDP Growth Rate. June 24, 2021.

4 Deloitte Economic Outlook. 2021.

5 The Conference Board of Canada. July 6, 2021.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. June 30, 2021. Index performance is based on total returns and expressed in the local currency of the index.

 

 

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Q3 2021 Outlook

Section 1: Q3 2021 Outlook

 

Despite the robust underlying strength in the global economy, COVID remains a threat. With the Delta variant spreading more easily, it now looks likely that global infections this quarter will push well above the second-wave peak. The recent surge in infections in high vaccination rate countries is a surprise. In the past four weeks, U.K. infections have approached their January highs and a clear upturn is also underway across Europe and the U.S. While vaccines are important for minimizing the damage, the projected surge in case counts among the unvaccinated could still overwhelm health care systems.

 

How Will Canada Fare in the Recovery?

In this Q3 Outlook, we are taking a closer look at Canada and the opportunities that position the country for recovery. Canadians have responded very positively to vaccine rollout and there is little sign of a new outbreak in Canada. New COVID-19 cases have trended up across the border in the U.S. in recent weeks due to the more contagious Delta variant, mostly in states with low vaccination rates. Recent data for Canada are highly encouraging as the share of the population that has received at least one dose is one of the world’s highest. The vaccination campaign has seen about 70% of the population inoculated with at least one dose and about two-thirds of Canadians fully vaccinated. The number of daily new cases is the lowest in 10 months and new cases are concentrated in younger age groups, whose vaccination rates are lower (no vaccines are authorized for those less than 12 years old).

Hospitalizations have been falling in recent weeks, allowing an easing of public-health restrictions. In addition, the government has now permitted fully vaccinated citizens and permanent residents of the U.S. currently residing in the U.S. to enter Canada beginning August 9th. Provinces are easing local restrictions gradually, and high-frequency mobility indicators from Google and Apple have trended up in recent weeks. Hurdles to overcome include vaccine resistance among some segments of the population and the persistence of COVID-19 variants that continue to pop up.

 

Canada Emerging from 2020

Canadian household wealth rose in 2020. Households’ net worth climbed to a record level in 2020 as government supports and price appreciation pumped up asset balances. Currency and deposit holdings increased a whopping $205 billion over 2019, the latest indication of the exceptionally large store of household savings that were accumulated over the pandemic.i

Government transfers to households increased by $117 billion.ii Mortgage debt rose by $110 billion over 2019, but house prices rose more as residential real-estate markets roared back following spring lockdowns. Net household equity in real-estate rose by a whopping $531 billion in 2020. Non-mortgage household debt (e.g., credit cards) actually declined last year with households prudently using some excess cash to carry smaller debt balances. The debt-to-income ratio remains exceptional high at 175.0% albeit still well below 2019 levels.iii

Wages and salaries fell a cumulative $36 billion through 2020 relative to pre-shock (Q4/2019) levels as unemployment spiked. Resurgent stock markets boosted end-of-year financial asset holdings by $291 billion from year-ago.iv

 

Canada in 2021

The Canadian economy expanded 1.4% in the first three months of 2021, slowing from a downwardly revised 2.2% rise in the previous period but still marking the 3rd consecutive quarter of growth.v Government transfers to households and businesses continued, and an improved labour market continued to support housing investment and household spending. Housing investment expanded 9.4% but rising input costs heightened construction costs. Also, household spending increased 0.7%, with the biggest increases seen for information processing equipment (+18.7%), major tools and equipment (+13.8%), and games, toys, and hobbies (+25%). On the other hand, business investment in machinery and equipment fell 2.7%, because of a sharp decline in investment in aircraft (-98.7%), as a large number of used aircraft were disposed of through international exports. Export rose 1.5% and imports 1.1%.

Second quarter growth in Canada is coming in lower than in the U.S. because of more restrictive public-health measures. The Canadian economy shrank for the first time in a year in April, contracting 0.3% month-on-month.vi Given April’s showing, economic output was 1.1% below its pre-pandemic (February 2020) level. Statistics Canada also produced a flash estimate for May GDP, which again showed a 0.3% contraction for the month. This number pales in comparison to the whopping 18% drop over March and April last year during the first virus wave.vii

Weakness was concentrated in industries impacted most by virus spread/containment measures. Virus spread and re-imposed containment measures in ‘high-contact’ service-sectors pushed accommodation and food services sales down 4.6% from March. Retail sales also pulled back with stores either closed or operating at reduced capacity but remained about 2% above pre-shock (February 2020) levels. Manufacturing output dropped 1% with a shortage of semiconductor chips pushing motor vehicle production down over 20%. But construction spending increased, and mining output continued to surge alongside high commodity prices.viii

As we begin to recover, Canadians are poised to quickly deploy spending as the economy gradually reopens. June output is expected to look better as the economy opened up further and with vaccine distribution continuing to ramp up, the hope remains that this time the reopening will be more sustainable. The Canadian economy has already recovered nearly 80% of the jobs lost during the recession last year. That said, there are still a large number of Canadians unemployed – the unemployment rate was 8.2% in May, falling to 7.8% in June.ix As is apparent in many economies, jobs for lower income Canadians remain well below pre-pandemic levels. Fortunately, many Canadians have built up their savings over the past 14 to 15 months due to their inability to spend on services like travel and meals out.

 

A Closer Look at The Oil and Gas and Mining Sectors in Canada

As Canada moves towards a recovery, commodity demand and pricing will have a significant impact on Canada’s growth, relative to non- resource-based economies.

 

The Canadian Energy Industry

• Canada’s energy sector accounts for over 10% of nominal Gross Domestic Product (GDP).
• Government revenues from energy were $17.9 billion in 2018.
• Canada is the sixth largest energy producer, the fourth largest net exporter, and the eighth largest consumer.
• In 2019, Canada’s energy sector directly employed more than 282,000 people and indirectly supported over 550,500 jobs.x

 

Fed policy is important to the global economic recovery and capital flows but is secondary to global fundamentals in oil markets. Oil prices have climbed nearly 50% this year as key economies such as the U.S., U.K., and China have reopened, buoyed by mass vaccination campaigns. Crude stockpiles in China, the world’s biggest importer of crude, have dwindled to the lowest this year. As India emerges from a deadly coronavirus surge, an uptick in local fuel consumption has prompted the nation’s biggest refiner to boost production. Re-opening of major economies will boost refined-product demand in oil markets – e.g., gasoline and jet fuel – going forward, which will leave refiners little choice but to continue drawing on inventories to cover supply shortfalls in the near term.

While the forecasted rebound in global oil demand continues to drive expectations for higher prices, it is the production discipline of OPEC 2.0 and capital discipline imposed on U.S. shale producers that has and will continue to super-charge the recovery of prices. In July, the OPEC+ group reached an agreement to increase production by 400,000 barrels per day each month over the balance of 2021 as well as extend the cooperation agreement until the end of 2022. The group has agreed to higher reference production levels for all members, including the recalcitrant UAE. The group will meet again in September. We believe the agreement is in line with market expectations and that rising demand should absorb the planned increase in production.

OPEC 2.0 remains committed to its production management strategy that is keeping the level of supply below demand. Compliance with production cuts in May reportedly was at 115%, following a 114% rate in April. Core OPEC 2.0 – i.e., states with the capacity to increase production – is holding close to 7 million barrels per day of spare capacity, according to the IEA, which will allow it to continue to perform its role as the dominant supplier in our modeling. Earlier this year, KSA’s Energy Minister Abdulaziz bin Salman correctly recognized the turn in the market that likely ensures OPEC 2.0’s dominance for the foreseeable future including the shift in focus of the U.S. shale-oil producers from production for the sake of production to profitability. This is a trend that has been apparent for years as capital markets all but abandoned U.S. shale oil producers.

Producers outside OPEC 2.0, the “price-taking cohort”, have prioritized shareholder interests as a result of this market pressure. Large producers are expected to shed production assets to reduce their carbon footprints, so as to come into compliance with court-ordered emission reductions and shareholder demands to reduce pollution. With the oil majors like Shell, Equinor, and Oxy already divesting themselves of shale properties, production increasingly will be in the hands of firms driven by profitability.xi

 

Income Drives Oil Demand

NOTE: SHADED AREA DENOTES FORECAST.
SOURCE: US EIA, OPEC, IMF, BCA RESEARCH.

 

The Canadian Mining Sector

• In 2019, Canada’s mining sector contributed $109 Billion, or 5%, of Canada’s total nominal GDP.
• Canada ranks among the top five countries in the global production of 17 minerals and metals.
• Valued at $106 billion in 2018, mineral exports accounted for 19% of Canada’s total domestic exports.
• The industry’s direct and indirect employment accounts for 719,000 jobs, accounting for one in every 26 jobs in Canada.
• Proportionally, the mining industry is the largest heavy industrial employer of Indigenous peoples and provided over 16,500 jobs to community members.xii

 

Copper and aluminum will remain well bid in the face of constrained supply and higher consumption ex-China. Despite China’s widely anticipated decision to release strategic stockpiles of copper, aluminum, and zinc next month into a tight domestic market, continued inventory draws will be required to cover physical deficits in these markets, particularly in copper.

As demand for industrial commodities increases and inventories continue to draw, forward curves will become more backwardated as material delivered promptly (next day or next week) will command a higher price than commodities delivered next month or next year. Consumers value current supply above deferred supply, and producers and merchants must charge more to cover inventory replacement costs, which increase when prompt demand outstrips supply.

 

Will Rising Resource Prices Lead to Inflation in Canada and Abroad?

Canada’s headline inflation rate was the highest in a decade in May. Headline CPI rose 3.6% year-over-year in May, 2.4% excluding food and energy components. Higher costs for homeowner replacement and passenger vehicles supported rise in core prices.xiii

Headline inflation rose 3.6% from a year ago in May, the highest in a decade. Energy prices were up 26.4% from exceptionally low year-ago levels and accounted for almost half of the increase, despite moderating slightly from April’s 32.7%. Growth for food prices rose 1.5% from already-strong levels last May and will probably continue to grind higher on the back of elevated agriculture commodity prices. Outside of food and energy, prices rose 2.4% from May 2020, faster than April’s 1.8% pace. Still, price growth has been increasingly broadly based. 58% of goods and services in the consumer index basket were up 2% or more (on a 3-month rolling average basis) in May, up from 54% in April and well-above the 40% trough in September 2020. The Bank of Canada’s preferred ‘core’ measures all increased again in May. There have been some early signs of easing in some of the supply chain disruptions that sent industrial production input costs soaring. Raw lumber prices, for example, have moderated sharply in recent weeks (albeit to still elevated levels.) But consumer demand is set to surge as the economy reopens, and that demand, particularly for purchases of services, is expected to take over as a key driver of price growth in the second half of 2021.xiv

In the U.S., inflation has been much higher. Three months to May core inflation reached 8.3% on an annualized basis, the highest rate since the early 1980s. In June the Institute for Supply Management’s index of changes in the prices paid by American manufacturers registered its highest reading since 1979, a year in which consumer prices rose by 13.3%. Inflation in other rich countries has been more modest. But it has still exceeded expectations. In the Euro area headline inflation year-over-year has risen from 0.9% to 1.9% since May, touching the European Central Bank’s target of “below, but close to 2%”.xv

Much of this is due to base effects; core consumer prices fell between February and May, as they did in Japan. Britain is an intermediate case. Headline inflation is roughly on target, but core consumer prices have accelerated. This is not just an issue for rich countries. A measure of aggregate inflation in emerging markets produced by Capital Economics, a consultancy, rose from 3.9% in April to 4.5% in May. Rising inflation has set off a cycle of monetary tightening. Since the start of June, central banks in Brazil, Hungary, Mexico, and Russia have raised rates.xvi

 

Has the Pandemic Enhanced Structural Changes to Inflation?

Many of the structural factors that have suppressed inflation over the past 40 years are reversing direction. Globalization is in retreat; the ratio of global trade-to-manufacturing output has been flat for over a decade. Looking out, the ratio could even decline as more companies shift production back home to gain greater control over unruly global supply chains.

Despite a pandemic-induced bounce, underlying productivity growth remains disappointing. Slow productivity growth could cause aggregate supply to fall short of aggregate demand.

 

Short- and Long-Term Inflation Factors

In the short term, the factors pushing inflation higher are threefold. The first is a boom in demand for goods like cars, furniture, and household appliances set off by consumers splurging on things that made lockdown homes nicer and life outdoors more enjoyable. The second is disruption in the global supply of some of those goods. A shortage of microchips, for example, is severely curtailing the supply of cars. A higher oil price does not help. Disruption in the global shipping industry and at ports exacerbates things in various markets. The third—probably the most important, and the one only now fully coming to be felt—is a rebound in the prices of services. Consumers are returning to restaurants, bars, hairdressers, and other in-person businesses faster than workers are.

A sustained rebound in inflation would be bad news for two reasons:

1) Inflation hurts. Life-satisfaction surveys carried out in the 1970s and 1980s found a one-percentage-point rise in inflation reduced average happiness about as much as a 0.6-percentage-point rise in the unemployment rate. If it catches workers by surprise, it erodes their wages, hurting the lowest paid the most; if it catches central banks by surprise, they may have to slow the economy, or even engineer a recession, to put the beast back in its cage.

2) Inflation has the potential to up-end asset markets. The sky-high prices of stocks, bonds, houses, and even cryptocurrency rests on the assumption that interest rates will stay low for a long time. That assumption makes sense only if central banks do not feel forced to raise them to fight inflation. If prices rise too persistently, the financial edifice that has been built on years of low inflation could lose its foundations.

 

Inflation Threats Within Our One Year Time Horizon

In the U.S., 27% of the index is skewed by the re-opening trade and supply chain issues and the other 73% was not distorted by the pandemic. In Canada, the spike in May’s CPI – up 0.5% month over month – lifted the year over year pace to a decade-high of 3.6% from 3.4% in April. As was the case in the U.S., 27% of the index was skewed by the re-opening trade and supply chain issues while the other 73% was not distorted by the pandemic. The segment of the CPI (auto purchases and leases, home improvement, furniture/appliances, recreational services and the like) that is COVID-19-skewed saw prices soar 1.8% in May; the 73% share not being distorted was basically flat (+0.1%).xvii

Rising energy and commodity prices, production bottlenecks due to the shortage of some input components, and raw materials and capacity constraints vis-à-vis booming demand both at home and abroad are expected to put upward pressure on consumer prices this year.

 

Our Long- Term Inflation Outlook

• Outside of a few industries, wage inflation remains well contained. In those industries suffering from labor shortages, the expiration of emergency unemployment benefits, increased immigration, and the opening of schools should replenish labor supply.
• Bottlenecks in the global supply chain are starting to ease. Many key input prices have already rolled over, suggesting that producer price inflation has peaked and is heading down.
• A slowdown in Chinese credit growth could weigh on metals prices during the summer months, which would further temper inflationary pressures.

In 2022, we expect pressures to moderate gradually as supply constraints resolve, order backlogs clear, and demand growth moderates. The likely path of U.S. yields is central to a debate currently influencing markets: whether the signs of accelerating inflation around the world are transitory or more lasting, and how central banks will respond to price pressures during a post-Covid economic rebound. We continue to see high global inflation as a long-term risk rather than a short-term problem.

 

 

Section 2: Three Themes

 

Theme 1: The U.S. Economy is Recovering but is Subject to Setbacks

After an expansion of 6.4% annualized in the first quarter of the year, Q2 is expected to be stronger. As in recent months, household spending is likely to be the main driver. Business investment should also contribute to growth. Residential investment, meanwhile, could be set for a pause after several months of strength. It will take more time for the upside effects of reopening to be fully reflected in the labour market numbers.

Back in March, the Fed projected no hikes until 2024. The Fed jolted markets on June 16th after the FOMC signaled it may raise rates twice in 2023. The Federal Reserve began closing the door on its pandemic-driven monetary policy as officials projected an accelerated timetable for interest rate increases, opened talks on how to end crisis-era bond-buying, and said the 15-month-old health emergency was no longer a core constraint on U.S. commerce.

Signaling that broad changes in policy may happen sooner than expected, U.S. central bank officials moved their first projected rate increases from 2024 into 2023, with 13 of 18 policymakers foreseeing a “liftoff” in borrowing costs that year and 11 seeing two quarter-percentage-point rate increases.xviii A flattening in the yield curve that has continued since the fed announcement is a market signal of slower economic growth ahead.

 

Theme 2: China is Cooling

China’s economy, well-placed to benefit from strong international demand for merchandise, recovered rapidly from the initial shock of Covid-19. It is the only large economy that expanded in 2020. As the rest of the world is recovering from the pandemic, China has struggled with additional waves that have resulted in rolling shutdowns in primary industries.

Chinese credit growth and base metals prices are strongly correlated. Chinese authorities are not expected to embark on a new deleveraging campaign. Credit growth has already fallen back to 11%, which is close to the prior bottom reached in late-2018. To the extent that changes in Chinese credit growth affect commodity prices with a lag of about six months, metals prices could struggle over the summer months. China’s plan to release metal reserves into the market could further dampen prices.

 

Theme 3: Gold Continues to Be a Portfolio Stabilizer

Gold is sensitive to Fed policy and forward guidance. Its price will continue to be volatile as the widening dispersion of views evident in the Fed dots keeps markets on edge and pushes forward rate expectations in different directions.

Gold volatility will also remain elevated as markets factor in oil price volatility that will increase with steeper backwardation and base metals volatility that will rise as fundamentals continue to tighten.

 

 

Section 3. Investment Outlook

 

Global Pandemic Leads Us to a Growth Forecast for the Next Three Months Followed by Nine Months of Stagnation

SOURCE: FRAME GLOBAL ASSET MANAGEMENT

 

Frame Global Asset Management considers these trends and factors them into our outlook for the economy in our twelve-month forward period. We look back to periods of similar economic behavior and use this information to predict the future behavior of the asset classes that we consider. Our investment process allows us to adapt for non-traditional monetary policy and other exogenous variables.

 

 

Section 4. June 2021 Portfolio Models

The macroeconomic environment was a key focus in May. Massive fiscal support has been the glue that has held the economy together but the re-opening contribution to growth is for the most part completed. The question of whether the change in consumer prices is transitory or a regime shift will determine the sustainability of economic growth. We have maintained our economic outlook of three months of Growth followed by Stagnation for the remainder of our twelve-month forecast horizon.

In June, we maintained the asset allocation we established in May. Equity exposure across all models reflects our view that markets are looking through the uncertainty of the pandemic and towards the resumption of more normal life once populations are vaccinated. The recent shift in the bond-equity correlation into positive territory appears to be a function of the persistency in inflation. Fiscal spending that funds local governments supports our exposure to treasuries and municipal bond exposure in the U.S. We continue to include exposure to gold as a portfolio stabilizer.

The economic reopening and the global stimulus that is underway will lead to improved household liquidity, healthy consumer balance sheets, and a healing labor market.

 

Deborah Frame, CFA, MBA

President and Chief Investment Officer

July 14, 2021

 

iTrading Economics. Canadian Household Wealth, Credit Market Debt to Total Income. June 2021.
iiTrading Economics. Canadian Government Spending. June 2021.
iiiTrading Economics. Canadian Household Wealth, Credit Market Debt to Total Income. June 2021.
ivTrading Economics. Canada Hourly Average Wages. June 2021.
vTrading Economics. Canada GDP Growth Rate. June 1, 2021.
viTrading Economics. Canada GDP Growth Rate. June 1, 2021.
viiTrading Economics. Canada GDP Growth Rate. June 1, 2021.
viiiTrading Economics. Canada GDP Growth Rate. June 1, 2021.
ixTrading Economics. Canada Unemployment Rate. July 9, 2021.
xStatistics Canada. Canadian Energy Data. June 2021.
xiBank Credit Analyst. June 17, 2021.
xiiStatistics Canada. Canadian Mining Data, Natural Resources Canada. June 2021.
xiiiTrading Economics. Canada Inflation Rate. July 28, 2021.
xivTrading Economics. Canada Inflation Rate. July 28, 2021.
xvThe Economist. July 11, 2021.
xviCapital Economics. June 2021.
xviiTrading Economics. Canada Inflation Rate. July 28, 2021.
xviiiThe U.S. Federal Reserve System. June 16, 2021.

 

 

 

 

 

 

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June 2021

The macroeconomic environment was a key focus in May. Massive fiscal support has been the glue that has held the economy together but the re-opening contribution to growth is for the most part completed. The question of whether the change in consumer prices is transitory or a regime shift will determine the sustainability of economic growth. We have maintained our economic outlook of three months of Growth followed by Stagnation for the remainder of our twelve-month forecast horizon.

China’s economic data came in weaker than expected in April. A fall in retail sales and industrial production contributed to the weaker result. China’s urban unemployment rate edged down to 5% in May 2021, the lowest in two years.1

The Euro Area economy shrank 0.3% in the first three months of 2021. Among the bloc’s largest economies, Germany, France, Spain, and the Netherlands fell back into contraction territory, while Italy’s economy posted modest growth despite the restrictions.2 The consumer price inflation rate in the Euro Area was confirmed at 2% year-on-year in May 2021, the highest since October 2018, due to the low base year. Upward pressure came from energy (13.1% versus 10.4% in April).3 Amongst the largest Euro Area economies, the highest jobless rates were recorded in Spain (15.4%), Italy (10.7%) and France (7.3%).4 Britain’s job market showed signs of recovery. In the three months to April, it stood at 4.7%, down from 5.1% at the end of 2020.5

Thanks to an extremely accommodative policy mix, the U.S. economy continues to recover, growing by an annualized 6.4% in the first quarter.6 After a decade of disappointment, U.S. productivity growth is on the rise again. Time will tell if this is a structural upshift that will be sustained. The U.S. unemployment rate dropped to 5.8% in May 2021, the lowest since March 2020.7 The annual inflation rate in the U.S. accelerated to 5% in May of 2021 from 4.2% in April, the highest reading since August of 2008 amid low base effects from last year, rising consumer demand as the economy reopens, soaring commodity prices, supply constraints, and higher wages as companies grapple with a labor shortage. This inflation is uneven with the 20% that is COVID-19-skewed, up at a 22% annual rate over the past six months, while the other 80% that represents the part of the economy not being affected has seen its CPI rise at a 1.6% annual rate and was up 0.15% in May.8 At the June meeting, The Federal Reserve held its target range for interest rates steady at 0% to 0.25% but said it will probably increase it by the end of 2023 to 0.6%. The hike will come sooner than the Fed had expected in March, mostly because of a faster pandemic recovery, vaccination uptake, and rising domestic inflation.9

Canadian GDP is estimated to have gone down in April, the first decline since the spring of last year due to the third wave lockdown. Canada’s annual inflation rate quickened to 3.6% in May of 2021 from 3.4% in April. The Canadian dollar has appreciated to above 83 US cents, up from 78 cents in January. The Bank of Canada has attributed much of this increase to improving fundamentals like rising commodity prices.10

U.S. equities ended May on a modest note as inflation concerns dominated the headlines. The S&P 500 posted a gain of 0.7%, the S&P MidCap 400 posted 0.2% and S&P SmallCap 600 posted 2.1%. Canadian equities gained in May, with the S&P/TSX Composite up 3.4%. The S&P Europe 350 added 2.7%, making several new all-time highs. The Australian benchmark, S&P/ASX 200, closed the month up 2.3%. Most Asian single-country indices posted gains in May, including the S&P China 500 up 1.3%, and the S&P Korea BMI, up 0.7%, while the S&P Singapore BMI was down 0.6%.

In June, we maintained the asset allocation we established in May. Equity exposure across all models reflects our view that markets are looking through the uncertainty of the pandemic and towards the resumption of more normal life once populations are vaccinated. The recent shift in the bond-equity correlation into positive territory appears to be a function of the persistency in inflation. Fiscal spending that funds local governments supports our exposure to treasuries and municipal bond exposure in the U.S. We continue to include exposure to gold as a portfolio stabilizer.

The economic reopening and the global stimulus that is underway will lead to improved household liquidity, healthy consumer balance sheets, and a healing labor market. Our approach to portfolio management is nimble, opportunistic, and deliberate in identifying asset classes that are best placed to generate returns in a new world order. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame, President and CIO

 

1 Trading Economics. China Retail Sales, National Bureau of Statistics of China. June 9, 2021.

2 Trading Economics. Euro GDP, EUROSTAT. June 8, 2021.

3 Trading Economics. Euro Area Inflation. June 17, 2021.

4 Trading Economics. Euro Unemployment Rate. June 1, 2021.

5 Trading Economics. U.K. Unemployment Rate. June 15, 2021.

6 Trading Economics. U.S. GDP. June 4, 2021.

7 Trading Economics. U.S. Unemployment Rate, Bureau of Labor Statistics. June 4, 2021.

8 Trading Economics. U.S. Inflation Rate. June 10, 2021.

9 The Federal Reserve. FOMC Statement. June 16, 2021.

10 Trading Economics. US CAD Exchange Rate, Statistics Canada. June 16, 2021.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. May 31, 2021. Index performance is based on total returns and expressed in the local currency of the index.

 

 

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May 2021

Economic activity has accelerated and is expected to remain strong into the third quarter of 2021, largely due to vaccination progress, economic re-opening, and large-scale fiscal stimulus. The U.S. is expected to be the principal driver of growth, followed closely by Europe as April restrictions are eased.

While the demand side of the global economy is heating up, the global growth boom underway is creating bottleneck pressures. Factory output has struggled to keep up with demand due to pandemic-related restrictions and shortages of intermediate inputs. Much of the year-over-year price increase can be attributed to base effects, coming off the low point for demand that occurred one year ago. The remainder of this recent inflation push is due to temporary factors such as stimulus-driven demand and supply chain restraints. The Fed and other developed global central banks have indicated that easing has reached a peak. Taper has started at the Bank of Canada and the Bank of England. As we monitor the recovery, we are aware that the global labor market is slow to heal, with the U.S. still 10 million jobs short of pre-pandemic levels.1 We have maintained our economic outlook of three months of Growth followed by Stagnation for the remainder of our twelve-month forecast horizon.

The Chinese economy advanced 18.3% year-on-year in the first quarter of 2021, boosted by strengthening domestic and global demand, strict virus containment measures, and continued fiscal and monetary support, and accelerating sharply from a 6.5% growth rate in the fourth quarter.2 China’s surveyed urban unemployment rate eased to 5.1% in April, compared to 5.3% in March and 6.0% in the same period last year.3

The Euro Area economy shrank 0.6% in the January-March quarter entering a double-dip recession, as several countries across the region imposed social distancing and lockdown measures to curb the spread of the coronavirus pandemic. Among the bloc’s largest economies, Germany, Italy, Spain, and the Netherlands fell back into contraction territory, while France’s economy returned to growth as the government delayed the imposition of lockdown.4

The U.S. economy grew by an annualized 6.4% in the first quarter, following a 4.3% expansion in the previous three-month period.5 With Janet Yellen and Jay Powell heading up macroeconomic and central bank policymaking, and with U.S. rates at the lower bound and the Fed having adopted Average Inflation Targeting, 2021 is likely to bring previously unseen coordination between the fiscal arm of the federal government and the central bank. Increases in personal consumption expenditures (PCE), non-residential fixed investment, federal government spending, residential fixed investment, and state and local government spending were partly offset by decreases in private inventory investment and exports.6 U.S. core consumer prices rose 3.0% in April 2021, the largest annual increase since January 1996.7

The U.S. Labor Department released soft jobs data for April 2021 showing an increase of 266,000, versus estimates for a 1 million gain.8 Canada’s job recovery hit a snag in April as a third wave of lockdowns across most provinces, including Ontario, led to fresh employment losses. The country shed 207,100 jobs in April, partially erasing large gains over the previous two months. The unemployment rate rose to 8.1% in April, from 7.5% a month earlier. Canada’s economy remains about half a million jobs shy of pre-pandemic levels.9

U.S. equities ended April on a positive note, with the S&P 500 posting a gain of 5.3%. Smaller caps also posted gains, with the S&P MidCap 400 and the S&P SmallCap 600 up 4.5% and 2.0%, respectively. U.S. fixed income performance was positive across the board. Canadian equities posted gains in April, with the S&P/TSX Composite up 2.4%. The S&P Europe 350 rose 2.2%, lifting its year-to-date return to 11.0%. The S&P United Kingdom outperformed, rising 4.0%, however the bulk of the European benchmark’s return was due to France, while Italy was a notable exception. Asian equities posted gains in April, with the S&P Pan Asia BMI up 1.8%. Most Asian single-country indices posted gains. Gold’s ability to protect against more than increases in the general price level suggests that its long-term real returns should be positive.

Equity exposure across all models reflects our view that markets are looking through the uncertainty of the pandemic and towards the resumption of more normal life once populations are vaccinated. In May, we maintained the asset allocation that we established in April. Fiscal spending that funds local governments supports our exposure to treasuries and municipal bond exposure in the U.S. We continue to include exposure to gold as a portfolio stabilizer.

The economic reopening and the global stimulus that is underway will lead to improved household liquidity, healthy consumer balance sheets, and a healing labor market. Our approach to portfolio management is nimble, opportunistic, and deliberate in identifying asset classes that are best placed to generate returns in a new world order. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame, President and CIO

 

1 U.S. Bureau of Labor Statistics. May 7, 2021.

2 Trading Economics. China GDP. April 16, 2021.

3 Trading Economics. China Unemployment National Bureau of Economics. May 11, 2021.

4 Trading Economics. Europe GDP. May 18, 2021.

5 Trading Economics. U.S. GDP. April 29, 2021.

6 Trading Economics. U.S. Inflation, U.S. Bureau of Economics. May 12, 2021.

7 Trading Economics. U.S. Inflation, U.S. Bureau of Labor Statistics. May 12, 2021.

8 Trading Economics. U.S. Employment, U.S. Bureau of Labor Statistics. May 7, 2021.

9 Trading Economics. Canadian Employment, Statistics Canada. May 7, 2021.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. April 30, 2021. Index performance is based on total returns and expressed in the local currency of the index.

 

 

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