Market Watch: June 2021
The global pandemic has changed Canadian’s lives in many ways. The isolation that continues in many parts of the country is trying even the most patient among us. There is, however, a light at the end of the tunnel (and no, it’s not a train!)
After a solid start to the year, global stock markets have been range-bound for the last few months as inflation concerns have taken the driver’s seat. I’ve heard from numerous investment professionals that although inflation is likely to be higher than in recent years, the current very high level reflects the global reopening and is expected to be transitory. It is expected, therefore, that some of these inflation concerns are overblown.
While North American stock markets have posted low double-digit returns in local currency terms, there have been a few headwinds to more broadly diversified portfolios. One factor has been the sudden rise of the Canadian dollar, which has appreciated more than 10% since late last year. Given that an allocation to US stocks is likely the largest single asset class in most client portfolios, this currency appreciation has somewhat compromised investment returns. The strong Canadian dollar has been driven both by US dollar weakness. As a cyclical economy, Canada has benefitted from the global economic reopening, where demand for commodities has risen significantly. Economic updates from several Canadian banks indicate that the dollar probably doesn’t have much upside from here, so this shouldn’t be as much of a headwind in the future.
Another factor that has been a drag on returns this year has been the sell-off in bonds. Due primarily to inflation concerns that may lead to higher interest rates (bonds are negatively affected by higher rates), the North American broad bond markets are down about 5% for the year. Given that most portfolios contain an allocation to fixed income/bonds, this has affected returns year to date. Even with this recent volatility, in an asset class that has low total return potential in the first place, bonds still do deserve a spot in most client portfolios. Bonds act as a stabilizer during stock market uncertainty and can protect on the downside when things are bad in the equity markets.
The third factor has been a rotation out of (in some cases, a fairly significant sell-off) some of the high-flying so-called “COVID winner stocks,” such as technology favouring reopening theme businesses. Many of the companies whose revenues are accelerating massively (think movie theatres, airlines etc.) right now are coming off a near-zero base, so it’s no wonder that their short-term business fundamentals look so robust. But many of these businesses do not have great long-term structural fundamentals. So while there has been some rotation within the funds that I recommend towards this reopen trade, most managers maintain their positions in better quality stocks with better long-term potential.
We have seen an increase in the appetite for risk among investors, with massive spikes both on the upside and downside in cryptocurrencies and the parabolic rise of so-called “meme” stocks. Of course, speculation has always been a factor within the stock market, but what’s new this time is that smaller investors are playing a bigger role, often acting in a coordinated fashion to bid up the price of generally lower-quality companies. While it may be interesting to see how this sideshow plays out, it likely won’t be a huge factor in long-term investment success. Instead, it is the long-term fundamentals of companies that are the most significant factors driving returns.
We also see the seeds planted for a potential shift in how corporations are viewed in the broader context of society. Certainly, institutional and retail investors are recommending greater clarity from companies in terms of ESG (Environmental, social, governance) risk factors. In the future, corporations may be expected to emphasize all stakeholders, including employees, not just shareholders. Talk of a global minimum corporate tax looks to level the playing field and ensure that companies cannot benefit from locating in friendlier tax jurisdictions.
To sum it up, 2021 appears to be a year where the baton is being passed from the narrow group of companies that led in 2020 pre-vaccine to the broader stock market, with a sharp rally in lower-quality stocks along the way, playing out against a backdrop of heightened inflation concerns. Of course, much of this inflation is likely to be transitory, and fundamentals always win out in the long run, so even if markets take a bit of time to sort themselves out, the overall picture is still quite healthy.
We are here to help you meet your investment goals, and we welcome your questions. Throughout the pandemic, we have continued to serve investors safely and comfortably by telephone and video calls, and now we are once again meeting clients in the office as desired. As we enter the 16th month of on-again, off-again lockdowns, we hope you are doing well and staying safe… not to mention sane. Hopefully, we can look forward to meeting in person soon. Have a wonderful Canada Day and a great (and hopefully less socially distanced!) summer.