Knowledge Centre

Investors have experienced a very rewarding first half of 2021, which has been rivaled only once in the past two decades, as unprecedented economic stimulus, stellar earnings growth and the gradual reopening of the world’s economy has powered many equity markets to all time highs. With the proportion of fully vaccinated people climbing in developed economies, the world’s economic activity should continue through the second half of 2021. Amid this backdrop, the focus for markets has shifted from the strength of the rebound to the implications for inflation and the timing of central bank moves to taper asset purchases and eventually raise interest rates.

With Canada’s vaccination rate ramping up and the widespread rise in commodity prices, the economy is on track for its strongest growth in 40 years. There is potential for an even more impressive growth rebound in the second half of 2021 as shuttered business reopen. The Canadian economy hit a rough patch in April and May but has proven to be surprisingly resilient despite the lockdowns. The Bank of Canada appears ready to keep interest rates steady until the second half of 2022. The worst appears to be over as far as COVID-19 is concerned.

U.S. economic growth accelerated, fueled by massive government aid, generating what is expected to be the strongest performance in nearly four decades. Still, the economy remains at least a couple of years away from fully recovering from the pandemic. Growth in consumption was especially strong, which has been a major driver of the gains in stocks as almost all sectors made gains over the past quarter. One of the biggest factors shaping investor outlook is inflation and whether the Federal Reserve Bank will rein in its easy money policies sooner than expected.

Recent weeks have produced encouraging signs that Europe is on the mend. Factories have revived production, and growing numbers of people are starting to experience a more normalized life. The Eurozone economy did contract in the first three months of the year, sliding back into recession, as the still raging pandemic prompted governments to extend lockdowns. The Eurozone is now expected to expand at a blistering pace over the rest of 2021 and into next year.
The U.K. economic outlook brightened due to falling inflation expectations and recovery in corporate profits as the dual headwinds of Brexit and the pandemic recede. Japan is expected to have a solid economic recovery through the rest of the year boosted by strong capital spending and a return to services activity; especially after slow progress in the initial vaccine roll-out. The Australian economy continues to exhibit solid growth, as it now has more people employed than before the COVID-19 outbreak.

Many equity markets have set all-time highs as confidence in the earnings recovery grows and the market slowly transitions back to normalcy. Investors have flocked to stocks as they tend to benefit the most from economic growth as the recovery from the pandemic began last year. Canadian stocks have been the leader of the pack, gaining 8.5% in the second quarter and 17.3% year-to-date (all figures in Canadian dollar terms) and have done so with very reasonable valuations. U.S. stocks climbed 7.1% in the quarter and 12.5% for the year. International stock rose 4.0% in the last three months and 6.4% YTD. Emerging market stocks were the laggards, only gaining 3.8% in the quarter and 4.8% for the year. Bonds achieved positive results of 1.7% in the third quarter after a brutal first quarter, such that for the year they are still down -3.5%.

The global business cycle is still in the early recovery stages following the lockdown induced recession. Investor sentiment has risen to record levels. Businesses are reporting strong sales outlooks, elevated investment intentions and record hiring plans. Consumers also have very high spending expectations reflecting a desire to unleash pent-up demand once restrictions are lifted. Of course, there are still obstacles ahead, but the outlook continues to be one of resounding promise.

The Canadian economy has been on a steady upward trend since its March 2020 lows when the pandemic erupted. It managed to survive brutal second and third waves but its resilience seemed to have faded at the start of the second quarter with real GDP declining 0.3% in April, after eleven consecutive months of gains. The pause in the recovery was primarily due to prolonged public health measures such as stay-at-home orders in some provinces, as well as disruptions in manufacturing amid chip shortages. The job market responded negatively with back-to-back jobs losses in April and May of 201,000 and 68,000 respectively; far worse than predictions. Despite the apparent economic setback, the stock market has been on a tear as investors’ confidence remained firm on the prospect for a higher turnaround in cyclical sectors of the Canadian economy. Canada’s main index, the S&P / TSX, closed the second quarter up 8.5%. Year-to-date, the index is one of the leading performers in global markets with a 17.28% total return; its best semi-annual performance since 2008.

Sector-wise, returns were mostly positive across the board apart from Health Care. Concerns of the reflation trade, defined as buying certain types of stocks during a recovery (i.e. inflation-proof and/or cyclical stocks) with the expectation that they will produce superior returns in an inflationary environment, appear to have abated. However, for most analysts these concerns seem transient, and rotation should not be ruled out in the long term. Among Cyclicals, Energy led with a 20% return, while other cyclical sectors posted more modest returns. Energy prices have risen over the last few months to a six year high on tight supply and full reopening prospects. Technology gained 15.8%, benefitting from the fading reflation trade. Initially the main theme was long term inflation, along with higher rates, and rotation out of growth stocks to value names. But as inflation fears eased, growth sectors such as Technology, due to their long duration, took advantage of lower rates at the long end of the yield curve. Financials closed with a relative decent 7.4% gain but still below expectations. However, its appeal for investors continues to be strong as Banks have clawed back most of their bad debt provisions which will help to quicken their return to normalcy when the economy fully reopens. On the flip side, only Heath Care closed with a loss, at -12%. The sector, and notably cannabis stocks, have been experiencing a rough ride amid regulatory hurdles at the provincial and federal levels and investors seeming to scale back their earlier zeal for these types of stocks.

The economy’s contraction in April amid containment measures to combat a third wave of COVID-19 was a setback to the strong momentum of the last few months. The good news is that the GDP decline was less than anticipated and for most analysts the pullback is temporary and far from a downward trend. The GDP forecast is still very positive as it is expected to close the year above pre-pandemic levels. The (Organization for Economic Cooperation and Development) sees the Canadian economy near the top of the list at yearend with more than 6% GDP growth. One of the key risks to these positive forecasts is the emergence of other variants of COVID-19, which may spark new business restrictions and lockdowns. However, Canada has increased the pace of vaccination in the last few months and the growing proportion of immunized Canadians should go a long way to avert extreme measures.

The TSX continues its upward trajectory thanks to the reflation trade that rotated from growth to value. Although that activity receded in the quarter with growth taking over value, Canadians as well as global investors are pricing in strong returns for the Canadian market over the next few months on further reopening and higher corporate earnings. It seems that the pandemic-driven exodus by foreign investors has ended and their confidence has been reignited as they poured back more than 22 billion dollars (USD) at the end of April, a trend that is not expected to reverse soon.

The FTSE Canada Universe Bond Index gained 1.7% during the second quarter of 2021 but has fallen 3.5% since the beginning of the year as the index fell 5.0% over the first quarter in the wake of a huge selloff in U.S. Treasuries. The Bank of Canada continues to keep its key interest rate unchanged at 0.25% and the U.S. Federal Reserve also maintained its rate at between 0.0% and 0.25%. Yields on 10 year Government of Canada bonds dropped slightly to the 1.4% level and the 10 year U.S. Treasury yield fell from 1.7% to 1.5%. The absolute level of long rates continues to be very low.

The Canadian economy has spent much of the first half of the year in varying degrees of confinement. These restrictions have caused gross domestic product (GDP) growth for the first half of 2021 to trend below the Bank of Canada’s forecast. First half GDP is expected to grow at around 3.8% versus an April forecast of 5.3% but the central bank is not particularly worried as Canada’s pace of vaccinations has picked up significantly. The Canadian dollar has been rising on a wave of optimism that has lifted commodities, particularly oil. A strong Canadian dollar hinders the export oriented sector but also reduces the cost of imports for Canadian buyers, thus cooling some powerful sources of inflation that have begun to emerge. The higher dollar can achieve some of the same goals as an interest rate increase without the rate increase. Rates will eventually increase but Canada’s close linkage to the U.S. means the first rate hike will likely be from the U.S. in 2023.

With the outlook for the economy improving, the Bank of Canada has accelerated its timetable for a rate increase as well as starting to end its Quantitative Easing (QE) bond purchases. The Canadian government is spending $101 billion, about 5% of GDP, to stimulate the economy over three years. QE, the purchase of bonds with newly created money, is about to enter a new phase as its justification has almost ended. Some central banks have already begun to scale back their purchases and in April Canada became the first major economy to signal its intent to reduce its level of monetary support. In the U.S. the Federal Reserve’s careful approach is likely meant to avoid a repeat of the 2013 “taper tantrum” which caused bonds to sell off sharply. The Fed has learned from 2018 and 2019 when it shrank its balance sheet significantly by allowing assets to mature and not reinvest the proceeds. Although lower bond yields help the government’s finances, QE does not remove the government’s financing costs, it just shifts them to central banks whose profits and losses end up with the taxpayer. Over the past decade, issuing short term liabilities to buy long term debt has been a profitable strategy. Between 2011 and 2020 the Fed sent over $800 billion in profits to the Treasury. If interest rates rise however, central banks’ enormous balance sheets could become lossmaking.

The U.S. economy is expected to grow 7.0% this year and 3.3% in 2022, with the unemployment rate expected to fall to 4.5% by the end of 2021 Since last summer the Fed has said that it will keep rates low until the economy recovers and inflation is sustainably hitting 2%. It is now expecting these two conditions to be met by the second half of 2022 instead of 2023. Fed policymakers expect to make two interest rate increases by the end of 2023. The Fed chair, Jerome H. Powell, sounded more positive about the outlook than he had just a few months ago, though he retained a note of caution. “We’re going to be in a very strong labour market pretty quickly here,” he said, while adding that the Fed was in no rush to raise interest rates and that “whenever liftoff comes, policy will remain highly accommodative.” The U.S. will not change its interest rate path until it sees employment levels rising, which should ease investor fears of an earlier than expected rate hike.

Economic data have offered surprises as employers have been hiring more slowly than they were in the spring and inflation has come in faster than expected but it should moderate over time as bottlenecks are resolved. The U.S. has put inflation to one side for now and will want to see a year’s worth of data before getting concerned. A more immediate priority for central banks is getting those who lost their jobs at the start of the pandemic back to work.

The tumultuous first half of 2021 saw U.S. equities advance strongly in the second quarter despite lingering concerns over COVID-19 as the Standard & Poor’s 500 index climbed 8.5% in U.S. dollar terms. Year-to-date the index is up 15.3%. In Canadian dollar terms the respective change was 7.1% for the quarter and an increase of 12.6% for the first half of 2021. The loonie gained 1.4% during the second quarter and is up 2.6% relative to the U.S. dollar since the beginning of the year.

The U.S. economy posted a very strong annualized growth rate of 6.4% in the first quarter and company earnings in the quarter were among the best ever recorded. That is quite a change from a year ago as the nation’s largest banks were anticipating economic devastation and set aside billions of dollars to mitigate the huge losses that were expected to follow. More recently, executives at Goldman Sachs, JPMorgan Chase and Wells Fargo have become bullish as they see their customers are well supported by stimulus money. Clients are itching to spend and businesses are both expanding and building new businesses. This has worked well for the banks as Goldman and JPMorgan reported profits roughly five times as high as in the first three months of 2020 thanks to a combination of strong business results and a reduction in the amount of money they had put aside to cover losses on loans. Wells Fargo reported profits that were seven times as high as the first quarter.

Certainly, there are many sobering issues to offset Wall Street’s optimism as infections and hospitalizations are still climbing in some areas of the country and the trends benefiting large banks have not reached Main Street businesses, many of which are still struggling. However, for the banks, the balance of evidence clearly tilts toward improvement. The banks have been major, if somewhat unintended, beneficiaries of the Federal Reserve’s interest rate cuts and bond buying programs which injected trillions of freshly created dollars into financial markets and helped bolster activity in mortgages, corporate bond issuance and deals. Since then the major U.S. stock market has soared more than 80%.

Looking forward, several banks have highlighted the impact of the stimulus checks on consumer accounts, a component of roughly $5 trillion the federal government has allocated to fighting the crisis over the last year. Many households have received additional $1,400 cheques which were part of the massive stimulus package approved in early March. The package also extended a government funded $300 weekly unemployment supplement through September 6. The influx of federal dollars has helped put the finances of American households on some of their firmest footing in years. The rapidly improving public health environment and the White House’s $1.9 trillion rescue package are positioning the economy for the fastest growth in nearly four decades this year. Growth is expected to top 7.0% which would be the fastest since 1984. It would follow a 3.5% contraction last year, the worst performance in 74 years.

As the bounce from pent up consumer spending fades, government and business spending is expected to pick up the baton. Inflation worries are likely to contribute to market jitters but it will take a lot of bad news to shift the central bank. Federal Reserve Chairman Jerome Powell appears to be winning over investors with the argument that the current surge in consumer prices won’t last because its comparisons are based on the depressed prices of a year ago. When news broke that U.S. inflation climbed to 5% in May for the first time since 2008, yields on the key 10 year Treasury note moved in the opposite direction, falling to a three month low of around 1.43% and confirming that inflation is not a concern.

All of this is contributing to what looks like a “Biden boom economy,” as the Princeton economist Alan S. Blinder has called it. Economic growth will almost certainly be spectacular for 2021 when compared with 2020 as the COVID-19 induced recession of last year is making many of the current growth numbers look very good.

When reflecting upon the international markets during the first half of 2021, it is clear, we are not completely done with COVID-19 concerns, but the data is trending positively and the recovery is here. The ongoing turnaround is being fueled by effective vaccines, record levels of government support, corporate earnings that are exceeding expectations by record levels and pent-up consumer demand. As we enter into the second half of the year, questions about what drives markets forward are now more focused on classic concerns regarding economic growth trends, inflation, company earnings outlooks and the trend of interest rates.

European businesses expanded activity at the fastest rate in 15 years in June as an acceleration in the vaccination program and the subsequent reductions in COVID-19 restrictions brought life back to the dominant service industry. In fact, Europe is rebound faster than previously expected, revising growth expectations for 2021 and 2022 upward. Consumption and investment are expected to be the main drivers of growth, supported by employment that is expected to move in tandem with economic activity. The economy dipped into a second recession in the first quarter, but now is a thing of the past. Although inflation risks are possible, the European Central Bank is expected to maintain its loose monetary policy and look through higher inflation expectations before it acts.

Meanwhile, the U.K. post-lockdown bounced back in services companies eased slightly in June as price pressures jumped by the most on record when more COVID-19 restrictions were lifted. Industrial activity expanded at its fastest pace on record, but that they faced the steepest rise in raw materials costs in well over two decades. These inflationary pressures saw prices bounced to the highest level in nearly 21 years. Still, the U.K. economy potentially could be spurred to the strongest post-recession global growth in 80 years. However, due to record high debt levels the country remains vulnerable to increased stress.

Japan’s economy shrank in the first quarter and continuing a swing between growth and contraction as its plodding vaccination campaign threatened to stall its recovery as other major economies appeared primed for rapid growth. Currently, it is suffering a resurgence in virus cases, with much of the country under a state of emergency. The yo-yoing economic pattern, is unlikely to stop until the country has vaccinated a significant portion of its population. The turnaround has been fragile, but the pandemic’s effects on Japan have been relatively mild compared with the havoc wreaked on the U.S. and many European countries. Still, complete recovery will continue to be an uphill battle.

International stocks have climbed close to record highs, although they have not been able to keep pace with North American markets so far this year. Still, for the second quarter collective international stocks gained 5.4% and 9.2% for the year-to-date (all figurers in U.S. dollar terms). European stocks have been the primary drivers so far, climbing 6.4% in the quarter and 10.1% for the year. Asian stocks dipped into negative territory in the past quarter, falling -3.7% which offset most of the gains in the first quarter; such that for the year-to-date they are only up 0.7%.

The global economics rebound from the pandemic has picked up speed but remains uneven across countries and faces multiple headwinds. Many countries would not see living standards reach pre-pandemic levels by the end of 2022. As long as the vast majority of the global population is not vaccinated, markets will remain vulnerable. Still favorable conditions will continue to fuel the markets expansion. However, this does not mean the progression higher in the markets will be smooth and steady.

The world’s economies began to face the pandemic at the same time but will exit at very different speeds. This means navigating a highly uneven global recovery is putting pressure on emerging market economies already struggling with weak growth and low vaccination rates. The recovery thus far is being led by advanced economies while emerging market economic growth has been stunted during the pandemic. Compounding these issues is the looming prospect of inflation and higher interest rates which could be particularly challenging for Emerging Markets as they could be faced with a trend toward low growth.

China’s recovery has picked up speed boosted by domestic consumption and foreign demand for Chinese made goods. It has largely shaken off the gloom from the COVID-19 pandemic. China posted a record 18.3% growth in the first quarter although the expansion will likely moderate later this year. Still, the economy is already above pre-COVID-19 levels and policy support is slowly being withdrawn. With the economy back on a more solid footing, the central bank and fiscal authorities are returning to a more neutral stance and is turning its focus to cooling credit growth to help contain financial risks. The principal concern is rising commodity prices and inflation as China’s breakneck economic growth has periodically been accompanied by surging prices that have provoked anger across the country.

The darkest cloud is hanging over India, which has seen daily cases of new infections breach the 400,000 mark in May before subsiding in recent weeks. The country has initiated lockdowns and curfews as it attempts to contain the expanding COVID-19 outbreak. This is currently having a significantly negative effect on economic activity but it is possible India’s full year outlook will turn around. Taiwan’s economy has surpassed pre-COVID-19 levels as the rate of new cases continue to decline which has allowed manufacturing to rebound. Russian markets have rallied thanks to increasing oil prices and decreasing geopolitical risks, however the central bank has raised its interest rate for the second time to tame inflation which is running at its highest level in almost five years.

Latin America has suffered a heavy human and economic toll from COVID-19, which may not be surprising given the pandemic’s reach in the region and inconsistent responses from its members. Mass protests broke out in Colombia fueled by anger over economic inequality. Meanwhile, surprise election results in Peru and Mexico have reshaped the political landscape. Port workers in Chile, called a strike and are crippling the economy. Brazil was the best performing market with currency strength amplifying gains. Inflation is starting to seriously impact the region as many nations are forced to raise interest rates to combat the problem.

Despite all the issues facing Emerging Markets in general, the equity markets did turn in positive results; but lower than in developed markets. As a whole, Emerging Markets gained 5.1% in the second quarter and 7.6% year-to-date (all figures in U.S. dollar terms). Eastern European stocks led the way, up 15.1% in the quarter and 18.1% for the year. They were followed closely by Latin American equities which also climbed 15.1% over the last three months but only grew 9.0% year-to-date. Asian stocks were the laggard gaining only 3.8% in the second quarter and 6.1% for the year.

The global economy has recovered from the pandemic sooner than most expected. Vaccinating as many people as possible is proving to be the best economic policy. Many economies are tantalizingly close to a normal state, though by no means all of them. And the critical factor in that disparity is unequal access to vaccines. If not addressed, the danger is that the COVID-19 pandemic could leave some of the Emerging Markets in trouble as gaps between the developed and the developing world widen.

After a tumultuous year brought on by the pandemic, the real estate market is showing some signs of recovery, albeit slowly, with sharp contrasts between sectors. There has been surging demand for real estate around world which can be traced back to multiple factors but principally low interest rates and higher potential returns. Capital is being deployed at an accelerated rate based upon the asset class’ performance since the lows of the pandemic as investors seek the relative returns that real estate and REITs can provide.

A shortage of industrial real estate during this current economic expansion has created attractive opportunities for investors. The performance over the last couple of years has been truly extraordinary and likely to continue for the foreseeable future. The sector benefits from stable rental income and increased e-commerce activity that has uplifted asset valuations. Industrial space is being gobbled up at a dizzying rate as companies expand their storage and fulfilment centres to cope with the demands of e-commerce.

The jury is still out on office space in the wake of COVID-19’s work from home mandates. Tenants may look for new workplace designs and amenities to meet changing employee expectations. The likelihood of a return to office work in some form, coupled with the possible reopening of businesses in the coming months, could lay the groundwork for an eventful remainder of the year. Sublets, which flooded the market during the pandemic, are being cancelled or leased up by new business which is a very good sign. Canada’s major office markets have fared well over the past year compared to our global counterparts.

Retail and hospitality real estate have witnessed a profound upheaval since the beginning of lockdowns. On the other hand, retail operations in enclosed spaces, like malls, are pleased with the performance of their grocery anchored retail centres which have performed exceptionally well. Still, some evidence has creeped in recently that suggested the commercial sphere could be set for a strong second half of 2021 with less turbulent market conditions and optimism emerging from the post-pandemic fueled surge.
Canada has fewer housing units per capita than any other G7 country so the fundamentals suggest that investments in housing makes a lot of sense. Before the pandemic hit, rental apartments were some of the most coveted commercial real estate assets but sales activity ground to a halt and many investors abandoned the sector. There now appears to be a thaw in this area, which could change quickly as supply of properties available for sale is limited. Canada has hardly seen any new rental development for years with roughly 80% of the country’s supply of apartment buildings being at least 30 years old.

From a performance perspective, REITs have generated some of the best returns versus other asset classes so far this year. Canadian REITs surged 11.2% in the second quarter and 21.5% for the year-to-date (all figures in Canadian dollar terms). Internationally the returns were not as outstanding but still quite significant climbing 9.0% in the quarter and 14.4% for the year.

With so much demand spilling in, the real estate space has largely become a seller’s market. As the economic outlook is strong and as many countries emerge from the pandemic, there is significant capital targeting real estate investments. However, the money needs to be deployed selectively. Investors must assess their risk adjusted return projections for each market and sector considering the recent economic volatility and evolving demographics.