Market Update - March 2021
Starting off on a lighter note—Forbes recently released their global billionaires' list, the top 10 Canadians for 2021 are:
David Thomson, 61 — $41.8B (Founder of Thomson Reuters)
Tobi Lutke, 40 - $9.8B (Founder of Shopify)
Jim Pattison, 92 - $9.6B (Grocery, forestry and media)
Anonthy von Mandl - $8.7B (Creator of liquor brands White Claw, Mike’s Hard Lemonade)
Lino Saputo, 84 - $5.7B (Founder of Saputo Dairy Empire)
Chip Wilson, 64 - $4.9B (Founder of Lulu Lemon)
Alain Bouchard, 72 - $4.2B (Chairman and CEO of Alimentation Couche Tard)
James Irving, 93 - $4.2B (Owner of J.D. Irving—a conglomerate of shipbuilding, frozen foods, retail and transportation)
Peter Gilgan, 70 - $3.7B (founder of Mattamy Homes)
Daryl Katz, 59 – $3.6B (owner of the Edmonton Oilers and Rexall Health)
Back to markets - Already one quarter completed in 2021, and although it featured few episodes of heightened volatility, the final picture is clear. Against a backdrop of rising interest rates, stocks have pulled ahead of bonds which are showing losses (chart below)
This outcome is largely a result of the substantial upward revisions to the growth outlook since the beginning of the year (chart below) brought on by the fall in new COVID-19 cases and, most importantly, the passage of the $1.9 trillion fiscal stimulus package in the U.S. in early March.
The ending of Q1/2021 also implies that we have just wrapped up the first year of the bull market that began on March 24, 2020. After such a stellar performance since then - the 75% rise in the S&P 500 represents the best first year of a bull market in over 60 years—one can reasonably question what Year 2 has in store.
What can history teach us? Since 1957, every second year of bull markets has ended with positive returns for an average gain of 13%. However, a correction of at least 5% and on average 10% has also occurred over these periods (chart below).
In either case, we would be surprised if the next 12 months turned out to be an exception to the rule. So, what are the key elements that will determine how bumpy the road ahead will be this time?
On the geopolitical front, there are two major issues that should keep the markets on their toes over the coming quarters—and both revolve around the Biden administration.
The first is the infrastructure spending plan and, more importantly, how this new spending will be funded! According to the details on March 31, it seems that Biden’s intentions regarding corporate taxes are in line with the plan presented by his team during the election campaign. Specifically, we are looking at an increase in the tax rate from 21% to 28% (it was 35% before Trump’s tax cuts). This would represent a drop of approximately 9% for S&P 500 earnings. However, this only marks the beginning of a long period of negotiation with Congress that could technically stretch all the way to September before a tax plan is passed. It is hard to asses to what extent this is already priced into stocks - the Biden administration has been quite clear in their intentions. Also, the tax hike comes at a time when economic activity has good momentum. For this reason, while we expect the tax hikes to cause some volatility, we don’t see them as a threat to the ongoing bull market.
The second question concerns the U.S. policy approach toward China. A tough stance towards China is a rare consensus subject in the U.S. and perceived as Biden’s weakness, according to recent polls (chart below).
But beyond the war of words, a fundamental issue that could heighten tensions between the two superpowers will be their respective approach to fighting climate change. The US hosted, April 22nd climate summit (which Xi Jinping is expected to attend) should reveal more. Our geopolitical analyst Angelo Katsoras recently suggested that if the U.S. and the European Union were to open the doors to a carbon tax on trade—the cost of which would fall heavily on China—it would have a number of geopolitical and economic implications.
On the macroeconomic front, we see three crucial variables for what is next.
The first is inflation, as the next few months should reveal significantly higher annual figures (chart below).
In theory, this bounce should not have an outsized impact on markets since (1) it is widely anticipated and (2) the Federal Reserve has already said it will essentially ignore any transitory pressure on prices. Nonetheless, significantly higher than expected numbers could certainly cause some turbulence.
The result of this ‘inflation worry’ has been an increase in interest rates (the second crucial variable to keep an eye on). The 10 year US bond rate has risen from 0.5% last March to nearly 1.7% today. While this may not seem like a major change, the negative effects of this key rate tripling have reverberated throughout the global economy (increased interest expenses for all, falling bond prices). In the short term, we expect rate increases to pause—however as long as economic growth remains strong, interest rates are unlikely to go much lower.
Lastly, the U.S. dollar—the third crucial macro variable—also requires special attention. While the U.S. dollar depreciated between April and December 2020, the Greenback has strengthened so far in 2021 (chart below), buoyed by a sharp improvement in the U.S. growth outlook.
Over a 12-month horizon, we continue to expect a weaker U.S. dollar environment, as suggested by the size of the budget and trade deficits (chart below). However, in the shorter term, the positive momentum from the fiscal stimulus and the effectiveness of the U.S. vaccination operation could result in a series of spectacular economic data south of the border. The USD$ could therefore remain strong for a few more months.
Emerging market (EM) equities are closely correlated to the U.S. dollar. While the rising USD has put negative pressure on emerging markets to start the year (as has the recent slowdown in Chinese manufacturing), we would expect the trend to reverse and EM to outperform if the U.S. dollar weakens.
Among the major stock market regions, one alternative that also tends to benefit from a strong global growth environment is our own Canadian stock market index. Indeed, the S&P/TSX heavy allocation to cyclical and value sectors (financials and commodities)—a disadvantage over the past 10 years, has proven to be an advantage in the first quarter of 2021 (chart below), and this trend could continue in the coming months.
Mortgage Rates Update:
Here are our rates as of today based on a $500,000 mortgage, 25-year amortization, and owner-occupied:
7 - year fixed: 2.29%
6 - year fixed: 2.14%
5 - year fixed: 2.14%
4 - year fixed: 1.99%
3 - year fixed: 1.84%
2 - year fixed: 1.84%
1 - year fixed: 2.29%
5-year variable: Prime—1.15% (effectively 1.30% right now)
Disclaimer: These rates are for information only and are not guaranteed until an application has been submitted to the bank. Rates are subject to change at any time without notice.
Enjoy the start of Spring!
-The Creed Capital Team