May 14, 2021

Financial letter, Spring 2021, 55^th edition

Return of the Roaring 20s

“Global economic prospects have improved markedly in recent months, helped by the gradual deployment of effective vaccines, announcements of additional fiscal support in some countries, and signs that economies are coping better with measures to suppress the virus.” (OECD, March 2021) According to the organization, prospects for an eventual path out of the crisis have improved, with encouraging news about progress in vaccine production and deployment and a faster-than-expected global rebound in the latter half of 2020, but there are signs of increasing divergence in activity developments across sectors and economies. Expectations for a stronger recovery are also being reflected in financial and commodity markets. Our scenario featuring the return of the Roaring 20s in 2021 seems to be confirming itself against the backdrop of a sustained recovery based on unconditional stimulating public policies and unbridled personal consumption.

Considering the excess savings socked away, estimated at $1.7 billion in late 2020, the excess savings accumulated by US households since the pandemic could reach $2 billion after American Rescue Plan Act cheques are cashed in April. A spark of optimism could supercharge consumer spending.

Desjardins Group is calling for global GDP growth of 6% in 2021.

Representing two thirds of GDP, households are a force to know and recognize. Now imagine the impact that companies could have if they were to put their shoulder to the wheel in rebuilding their inventory and investing in machinery and equipment! Note that the Biden administration is working on another stimulus plan in the order of $3 billion, of which approximately a third would be used to rehabilitate public infrastructure.

Worried about inflation? In the very short term, it could be as high as 4% in both the United States and Canada, for a number of reasons: deflationary shock in March, April and May 2020 on the calculation of annual inflation, increase in gas prices, weak dollar, and supply chain disruptions (including the impact of the Suez Canal obstruction in late March). According to the Fed and the Bank of Canada, this increase will be temporary, however.

The Fed forecasts inflation to be between 2.2% and 2.4% in 2021, 1.8% and 2.1% in 2022, 2% and 2.2% in 2023 and 2% long term.

Consistent with its forecasts, the Fed reiterated that the key rate will remain unchanged at 0.25% to the end of 2023.

Geographic allocation

United States

We continue to maintain overweight US equities in the geographic allocation. On one hand, the economic recovery will benefit from households’ excess savings and stimulating public policies. On the other, mass vaccination will give the US economy wings to move ahead of advanced countries this year.

Offering protection against inflation and benefiting from the improved economic outlook, the S&P 500 has in the past capitalized on episodes where bond yields have climbed. Out of a total of 8 episodes where 10-year Treasuries have started a bullish cycle, the S&P 500 ended the sequence in positive territory 7 years out of 8.

Canada

Like its neighbour, Canada will also benefit from unconditional public support from governments (Canada ranked second after the United States for its budget contribution as a percentage of GDP since the pandemic) and the central bank, consumer support (whose excess savings are estimated at some $175 billion) and the vaccination campaign. Desjardins Group anticipates economic growth of 6.3% in 2021, a level not seen since the 70s.

That said, Canada is well positioned to take advantage of the recovery of domestic and international demand. We believe that the following sectors will do well: financial, industrial, alternative energies, base metals and discretionary consumption.

Emerging countries

The outlooks for emerging countries are complex. While the heath situation is in some cases more worrisome, the US stimulus packages will help them. The United States is a net importer. Accordingly, each time it stimulates and supports its citizens, there is usually a tremor effect felt in emerging countries.

What’s more, after a weak rally by the US dollar since the start of the year, most prognoses are arguing for a weaker dollar (BCA Research, Credit Suisse, MRB Partners). The anticipated budgetary largesse, along with a Fed that is determined to anchor short-term rates as low as possible for as long as possible, along with the non-negligible possibility that the Biden administration will not be able to hike taxes enough to pay for its investments—resulting in deficit—all risk weighing on the US currency. A decline in the US dollar is often a harbinger of the outperformance of emerging countries. We recommend overweighting emerging countries.

Fixed income and bond strategies

According to our scenario of a return to the Roaring 20s in 2021, bond yields will continue to adjust upward. At year-end, we expect Canadian bonds to be between 0.40% and 0.50% for 2-year bonds, 1.00% and 1.10% for 5-year bonds, and 1.75% and 1.85% for 10-year bonds.

Our forecasts call for a prudent investment strategy and an underweighting in bonds in portfolios. Duration management proved to be a wise move in 2021. We support a shorter duration than our benchmark index. As part of the bond strategy, the duration of our bond portfolio is 3.6 years vs. 5.5 years for our benchmark.

Unlike 2020, fixed-income securities will drag down an adequately diversified investment portfolio; a negative return should be expected over a 12-to-18-month horizon. Nevertheless, bonds still serve as an insurance policy against bad economic and stock market news. They tend to preserve their value in times of adversity, as well as maintain their liquidity. This means they can be used as ammunition to be sold at a profit and redeployed to equities during declines.

Conclusion

Investing has always involved risks. This time, however, unorthodox risks, while well identified, are reining in overweighting and argue for a positioning marginally in favour of equities, without maximizing risk taking. Among the factors in question, there are first the risks of COVID itself and its variants, followed by the challenge of vaccination campaigns. Lastly, we can’t ignore the increase in interest rates and the inflationary potential.

Ultimately, we are remaining cautiously optimistic. While a Roaring 20s-style economic boom promises to energize the new economic cycle, the challenges of the pandemic and climbing interest rates and valuation multiples (already high for equities) temper our enthusiasm.

We hope that this information helps you better understand the markets. Please don’t hesitate to contact us if you’d like to discuss our investment strategies in more detail. We are committed to working ever harder to find solid opportunities in the financial markets, so as to help you reach your long-term goals.