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April 15, 2021

First quarter of 2021

Hello everyone,

We hope that you and your loved ones are doing well in these challenging times.

Just over a year has passed since the COVID 19 pandemic and strict government and public health rules first came into our lives. Now that the vaccine has arrived in our communities, we sincerely hope that the worst is behind us and that we'll be able to hug our family and friends soon.

Q1 2021 follows an extraordinary year in which all economic indicators dropped. Fortunately, the new economic growth outlook for this year is encouraging. The Federal Reserve expects an increase of between 5.8% and 6.6% for 2021 and between 3.0% and 3.8% in 2022, while the International Monetary Fund (IMF) anticipates similar growth, 5.5% in 2021 and 4.2% in 2022. This data reflects a 3.5% contraction in the global economy^{Footnote 1} in 2020.

What stood out this quarter

Clearly, the rise in interest rates on long-term bonds (10+ years) in both Canada and the United States was a big surprise. The rate on a 10-year US government bond (US 10-year Treasury notes) went from 0.917% on December 31, 2020 to 1.717% on March 30, 2021, an increase of +87%.^{Footnote 2}. The 10-year Canadian bond rate went from 0.67% on December 31, 2020, to finish the quarter at 1.53%, an increase of +128%.^{Footnote 3}. Better-than-expected forecasts for economic growth are one of the main reasons for this sudden interest rate hike.

What the rate hike means

There is an inverse correlation between interest rate fluctuations and bond values in our portfolios (mainly long-term bonds). In other words, when interest rates go up, bond values goes down. That's exactly what happened over the last 3 months, which saw the Canadian Universe Bond Index decline by 5.04%.

The rate hike doesn't just take a toll on the value of long-term bonds; it also negatively affects high-growth stocks, which are mainly in the tech sector. Although tech company stocks performed exceptionally well in 2020, this sector underperformed in the market overall in Q1. Why? A higher interest rate means that strong valuations in this sector can't be justified right now. Corporate debt now costs more, affecting future profits and income, and causing share prices to drop.

Lastly, in the United States, the 10-year bond rate is now higher than the average dividend yield on the S&P 500 Index, meaning investors can get the same return with a less volatile asset. Nevertheless, the S&P 500 Index ended Q1 with a return of +4.54% in Canadian dollars.

In Canada and around the world

Canadian equities stole the show in the first quarter with a return of +8.05%. The energy sector contributed significantly to the index's total return. This asset class is buoyed by positive economic outlooks for the coming months, driven by hopes that lockdowns will lift in the second half of the year.

The CAD/USD exchange rate ended the quarter at 0.796, an increase of +1.40% for 2021. The unprecedented US$1.9 economic recovery plan lowered the value of the US dollar, driving up the exchange rate.

International markets still present a good buying opportunity given that their multiples are lower than in North America. On the other hand, some European countries like France are still heavily affected by the pandemic, which can lower economic data in the short term. Conversely, the UK stands out in terms of vaccination, which is encouraging for the eurozone.

Longer-term outlook

Although Quebec and Ontario are entering the third wave of the pandemic, the longer-term outlook is encouraging for a few reasons, namely:

• Vaccination is going well in most countries
• Monetary and budgetary policies are still very accommodating
• The central banks continue to prioritize economic growth and job creation
• Canadian and American families have surplus savings in their nest eggs, which suggests a great deal of consumer spending when the economies finally open up

The data suggests that equities will continue to outperform fixed income in the coming months and years.

Today's market and economy are more unpredictable than ever before. While things are looking up, the pandemic and new COVID 19 variants continue to impact the economy and not all sectors are responding in the same way. Maintaining sound diversification in our portfolios and letting managers do some rebalancing will be key to optimizing performance while minimizing volatility.