We All Agree, Up To A Point

Why so much attention on the Federal Reserve and obsession over inflation? Because Central Banks usually end Bull markets and economic expansions when inflation heats up. But, this time it is a little more nuanced than in past cycles. Statements such as, ‘until substantial further progress has been made toward the Committee’s maximum employment and price stability goals’ and ‘Transient’ are open to interpretation.

What we can all agree on is that the economy is recovering thanks to an unprecedented amount of fiscal and monetary stimulation and that the recent spike in inflation and economic growth will recede. So, you can forget about the newspaper headlines and current economic conditions, they’re already baked into equity prices. However, beyond transient there is a wide spectrum of outcomes and possibly a Bear Market lurking.

So, I want to look at where we are today and how the future will contrast to these current conditions and what that might mean for the markets.


Let’s start with the economy. It’s ripping due to pent up demand and the enormous amount of stimulus that was injected by the government and Federal Reserve. Consensus believes that growth in GDP and earnings will peak in the second quarter. The Atlanta Fed expects growth to be 7.9% but that’s a drop from 13.7% in early May and analysts see earnings expanding by over 60%. But, growth is then expected to decline steadily to 2.4% by the fourth quarter of 2022 as some see a ‘fiscal cliff’ as government stimulus fades. Spending will shift from goods to services and there will be tax increases. The Delta variant could push us back towards shut down and auto and home sales are already declining as some fear that the consumer is tapped out. According to Rosenberg Research, whose advice we listen to, consumers bought more in the way of durable goods in the past fifteen months, 30% growth from pre-pandemic level, than they bought cumulatively in the prior six years. Furthermore, the Citicorp Economic Surprise Index has gone negative, meaning that current economic conditions are not meeting expectations, which is quite a contrast to a couple of months ago. Add to these concerns the recent flare up in the Covid Delta variant and slowing GDP in China. If this retraction is truly due to faltering demand, then the economic expansion scenario is in jeopardy, which is the Bear Market case.

Although I buy the slowdown argument, I’m not convinced that the consumer is tapped out. The regional Federal Reserve boards conduct regular surveys and the most recent one showed unfilled orders at a record high and inventories at a record low. So, the slowdown in sales maybe a reflection of supply shortages, not lack of demand. We also have the propensity to spend showing up in a shift from goods to services. Consumers want to travel, attend entertainment venues and go to restaurants. Furthermore, Europe’s economy is now coming around, so we face the prospect of a global synchronized recovery in the second half.

Supporting this is a record amount of savings, which represents latent spending that I’ll quantify later.

Evidence of this mixed message recently became apparent in the fixed income markets as 10 year Treasury yields dropped from 1.74% to 1.25% seemingly supporting the case for a weaker economy. However, this was not confirmed by the spreads between corporate and government yields, which invariably increase during economic slowdowns.


Obviously, everyone favors a strong economy, but they don’t want the inflation baggage that usually accompanies it. Here again we have the transient argument. Most of it is supported by the short-term economic strength factors that most see waning. But the Fed adds other things to this list, such as base effect. This is the difference in prices today compared to the depressed prices during the Covid lockdown. It is accentuated by supply shortages and one time stimulus cheques being spent. Their belief is that the secular forces that have held inflation down such as globalization and technology driven productivity will reassert themselves, and that’s probably true, but there are some big hurdles to overcome.

Let’s start with housing. It is one third of the consumer price index (CPI). It is calculated by imputing what it would cost a home owner to rent his own home, or Home Owners’ Equivalent Rent (HOER). It was up only 2% over the last year but home prices have increased by over 18% in that period and there is usually about a one year lag between home prices and HOER. In 1995, the last time core CPI was above 3%, HOER was 3.5%. Furthermore some of the house price inflation is due to low interest rates, so it draws into question why the Fed is still buying $40bn of mortgage- backed securities each month.

Wages are another factor in the inflation puzzle. The transition crowd says productivity will be enough to offset wage increases and the government says there are still 7.6 million fewer employed than before the pandemic, so we have a surplus. Yet a recent government jobs report known as the JOLTS survey showed 9.21 mn job openings, a record high. Almost equal to the number of people unemployed. So why hasn’t employment improved more? Well, there are a number of reasons. First, many think that people are staying home because the unemployment benefits are higher than what they can earn. Already, 22 states have eliminated a $300 per week entitlement to encourage people back into the workforce. Otherwise, we’ll have to wait until September when the government benefits end for about 3.6 million people to test this theory. If people do return to the workforce, it suggests that the transient economic growth may transition to something hotter than expected. There are others that are staying home, especially women, because they can’t find day care for their children or because schools aren’t open. This too should get resolved in September. One would assume that this could ease wage pressure. However, the fastest wage growth has been in leisure and hospitality, the lowest paying industries and difficult to automate. As an example, Domino’s Pizza is offering some delivery drivers $1000 signing bonuses and $25/hr. There are also significant mismatches by skills, industry and location suggesting continued labor shortages.

The average hourly earnings (AHE) of lower-wage production and nonsupervisory workers (81% of payroll employment) rose 9.3% over the past 24 months through May. That’s twice as fast as the 4.8% increase in AHE for high-wage workers. Prior to the pandemic, AHE was rising 3%. Although forecasts for wages are thought not to be an issue, the Biden government and the Fed are focused on equality and how labor’s share in corporate profits has declined. To accomplish this you need higher wages and some of this will either get passed-on in price increases or you will see a decline in profit margins. Bottom line, the working age population, excluding those over 65, is declining. Baby-boomers on the verge of retirement still account for 6.5% of the workforce. Furthermore, as they age, they create caregiver jobs that can’t be automated or shipped offshore. You also have people that had jobs in leisure, entertainment and hospitality that are committed to career changes to jobs that are more sustainable and less subject to layoffs. This aggravates the jobs/skills mismatch.

So, I don’t disagree that transitional inflation will recede but with wage and housing cost pressure likely to pick up and last longer, the base rate of inflation may be higher than expected. If it isn’t dealt with, it will work its way into expectations and tolerance for further price increases as seen in a Conference Board survey in June where inflation expectations for the next twelve months jumped to 6.7%. Obviously, this debate over the statistics won’t be known until they are published. That won’t do us much good as the market will have already reacted. So, to help anticipate whether inflation is going to be problematic or transient, one has to rely on some economic theory and a lot of it is getting discredited. It’s the basis for my conclusions. But if you’d rather forego revisiting some of your college economics, please feel free to skip ahead.

Economic Theory

The ‘Quantity Theory of Money’ was originally set forth by Irving Fisher nearly a century ago and reborn in the ‘60s by Milton Freedman. It is the basis for traditional economic thinking that equates stimulative monetary policy with inflation. Those educated in this thinking have been waiting for a bout of inflation since the first rounds of Quantitative Easing (QE) were introduced during the Financial Crisis in 2008. Because it didn’t happen, many think the theory is no longer valid along with the Phillips Curve that equates labor shortages with rising wages.

However, there is an explanation. Central Banks execute monetary policy through the commercial banks. They do this by buying bonds from the banks which creates free reserves. The banks can then make loans up to ten times the amount of free reserves. However, in the aftermath of the financial crisis, those free reserves simply replaced about $4tn of problem bank loans, and in fact, were not lent out as they soared from roughly $50 bn to $4.5 tn. Therefore, monetary policy was short circuited and there was no impact on Main Street. This time, in the aftermath of the Pandemic Crisis, the Central Banks again engaged in QE but instead funded government treasury issues that were given directly to citizens in wage and other subsidies, thus bypassing the traditional commercial banking methodology. As we have seen, it worked and spending on consumer goods has increased dramatically, not only stimulating the economy but also causing inflation. So, the theory seems to be working and the only debate is whether it can be sustained. However, this hasn’t been a perfect pass through. There has been a short circuit in the form of savings. Total deposits at commercial banks rose $3.5 tn since March, 2020 to $17.1 tn. Furthermore, debt to disposable income has dropped to 85.5% in Q1, the lowest since 1995. So the consumer has firepower almost equal to the size of the economy. Of course, not all of it will get spent as lower income earners will be more likely to consume than higher ones.

This latent spending power is likely to sustain a higher consumption level beyond the actual disbursements by the government and argues for a stronger economy.

Another thought I’d like to introduce relates to the definition of inflation. For official purposes, we only include certain items, those that affect our cost of living but not those that support it like financial assets. This is the divide between Wall Street and Main Street. All the financial stimulation that we have seen since 2008 has had a major inflationary impact on financial assets and real estate, and has contributed to the financial social divide that we face today. Although the politicians would like to blame it on the capitalists, they are fully complicit in providing the wherewithal for the gap to be created through their own misunderstanding and lack of proper inflationary accounting.

Deutsche Bank published a very good piece on some of the softer aspects that will influence inflation that I would like to paraphrase.

The philosophical shift in government thinking from the fear of inflation and the rising levels of government debt, which shaped generations of policymakers, is now being replaced by the belief that economic policy should now concentrate on broad social goals.

Concerns over high and rising levels of sovereign debt are being relaxed as inflation has remained contained despite low interest rates. Concerns over debt sustainability and inflation have diminished as politicians believe structural forces will continue to suppress prices.

Policy has moved beyond just stabilizing output across the business cycle.

Fiscal stimulus is off the charts while Central Banks have shifted to having a tolerance for high inflation. Price growth could regain significant momentum as the economy overheats in 2022. The sum of the stimulus so far is in excess of $5tn or more than 25% of GDP not including the proposed legislation and deficits that are likely to come in at around $3tn.

Today’s stimulus dwarfs that seen in 2008 and the early 1930’s. Around WWII, deficits remained between 15%-30% for four years and inflation was 8.4%/14.6%/7.7% in ‘46/‘47/’48, respectively.

The Fed’s balance sheet has almost doubled during the Pandemic to nearly $8tn. Compared to the 2008 Crisis when it increased a little over $1tn and then another $2tn over the next six years.

The Fiscal Deficit and Fed balance sheet expansion combined equal approximately 30% of GDP in 2020 and will remain around 20% in 2021. This kind of explosive spike in monetary policy has, for the last 200 years, coincided with a similar spike in nominal GDP. This coordinated monetary and fiscal response has practically no parallel in US history.

Another difference between today and 2008 is that real disposable income has hit an all-time high in the US despite a recession. Consequently, excess savings has reached $2tn or more than 10% of GDP. Assuming 25% of these savings are spent over the next 18 months plus the stimulus from Biden’s Jobs and Families Plan will be enough to push GDP to more than 5% above potential by the later part of 2022. Overheated economies are typically quickly followed by a sharp run up in inflation.

Furthermore, there is political pressure on the Fed to err in the direction of delaying policy tightening, especially while the Fed leadership is up for renewal next year. Today, inflation is much less important than in the Reagan/Volcker era. Today, the focus is on not only employment but also on greater equality in income and wealth.

Monetary policy operates with long and variable lags. So, if inflation overshoots excessively and persistently, what will the Fed do? It will be forced to act, which will likely be highly disruptive to the markets and economy.

The perception that is being engrained is that high levels of debt and high inflation are a small price to pay for achieving progressive political, economic and social goals. This will make it difficult to accept higher unemployment in the interest of fighting inflation.

Federal Reserve

Now let’s talk about the Fed. We know that at some point, they are going to do two things. First, they will ‘taper’ which means, buy fewer bonds and mortgage-backed securities each month until they don’t buy any. Then they will start to raise interest rates to ‘normalize’ policy. This has a number of consequences for the stock market. Initially, Fed tightening can cause a correction but doesn’t historically end a Bull market. Second, it can change the complexion of which industries perform better, and influences the growth/value strategy. And finally, too much tightening can end the market’s and economy’s advance? So, every Fed meeting and economic release is dissected for some nuance on the Fed’s next move. Chairman Powell has repeatedly said that they will not raise rates ‘until substantial further progress has been made toward the committee’s maximum employment and price stability goals’. So what does that mean? They’ve said they’re willing to let inflation overshoot for a while to get to a socially-adjusted, fuller employment. If we use that as a benchmark and we take the average increase in employment, 468k new jobs per month which was the average in Q2, then it will take until mid-2022 to reach their goal of pre-pandemic employment.

And how long is Transient? Are we talking about fiscal stimulation? If so, and it’s been a one shot, demand-boosting policy, then shouldn’t the US budget deficit recede back to normal? According to Rosenberg Research, when examining prior spikes in inflation and the Fed’s reaction, this suggests that it could take 14 to 22 months before they react.

And what is tolerable ‘inflation overshoot’? Here the Fed talks about symmetry. Well, inflation averaged 1.6% since 2011 and only 1.2% in 2020. So, you need 2.4% average inflation through the end of the decade until 2030, with occasional peaks of 3% or more.

The Fed has also said that it will wait for actual evidence of inflation or other imbalances. This is also quite a departure from past protocol where the Fed has anticipated economic conditions using its many forecasts. After all, monetary policy is a leading indicator and now, it will be used in reaction to a coincident indicator. Consequently, there is a risk that if inflation is more than transient, the Fed will be well behind the curve, which will require a greater than otherwise required reaction to get inflation in check. Can this even be contemplated in an over-leveraged world? If not, what is the antidote for inflation?

Regardless, the mid-June Federal Reserve meeting was a bit of a reality check. Their message wasn’t much different, but they did open the discussion on when they would start to taper. The first sign of monetary tightening. Otherwise, the focus was on what is referred to as the ‘dot plot’. This is a record of when each Fed governor feels interest rates should be adjusted. Until June, the belief was that rates would hold until 2023. But this meeting saw 7 FOMC participants anticipate at least one rate hike next year up from 4 in the previous meeting and of those seeing an increase, two thought there would be two rate hikes. So, what happened to waiting for maximum employment, actual evidence and patience with inflation overshoot? Sounds like someone is looking at economic theory, which is why I elaborated on it earlier, as their inflation expectations rose from 2.4% to 3.4%. The reaction in the bond market was immediate as the curve flattened. Two year yields rose and ten year yields dropped. The reason: tapering means fewer Fed purchases of shorter-duration bonds, which is what they hold. That puts upward yield pressure on the two year Treasury note. However, willingness to raise rates sooner shows an inclination to fight inflation and puts downward pressure on the ten year yield.

The stock market took its lead from the bond market where the ten year yields had already dropped from 1.79% in March to 1.25% by July 9th. As longer rates dropped, signaling lower GDP growth, the growth stocks outperformed value. Some extrapolated this as a sign of weakening economic growth. However, the yield spreads between government and corporate yields would have widened if that had been the case and they did not. Yet, the Fed has not implemented any changes, which suggests that the decline in the ten year yields could be due to technical factors. In the past twelve months, the Fed has purchased $1,395bn of securities and has flooded the banking system with deposits while loans have been weak. This has resulted in the banks also being big buyers of treasuries, $867bn, to invest the surplus funds which drives rates lower. Combined, they have purchased $2.26tn in securities. Basically, government deficits are showing up in savings accounts and paid down loans.

The real question is why the Fed is still buying $120bn of securities each month when the economy is at a new record high and inflation is above their 2% target? On balance, the Fed’s mid-June statement suggested that there was a greater propensity to fight inflation than what there had been earlier.

Regardless, there seems to be an intractable course towards higher interest rates. If the economy continues to grow and inflation remains hot, the Fed may be pushed to react sooner than they have indicated. This would be especially true if the termination of unemployment benefits and the return to school in September drive the unemployed back into the workplace. But even if things cool off, the Fed has indicated a desire to normalize monetary policy. Only an unexpected slowing in economic growth could trigger a reappraisal and with so much consumption firepower sitting in bank savings accounts, that’s a hard case to make.

Stock Market

So, what does this mean for the stock market? Obviously, the focus is on the Federal Reserve and how and when they will start to tighten monetary policy. However, an increase in interest rates is only the beginning of the end and in the current conditions, maybe the beginning will be signaled when the Fed starts to taper its bond buying. This usually gives the market a shake but doesn’t terminate the advance. However, below the surface of the general market’s trend there is a lot happening that will determine performance.

Active management has had several themes to play over the last fifteen months starting with the Covid pandemic benefactors such as Amazon and Zoom. Then there were the ‘stay at home’ stocks like Netflix and Home Depot. This was followed by the recovery names such as the autos, industrials and home builders. The next phase was performance by the ‘coming out’ companies which included restaurants and airlines followed by a recent sell off in value and rotation to growth as the 2-10 year treasury yield spread narrowing surprised the market and concerns over the Delta Covid variant increased.

This growth/value backdrop has been a pervasive theme for the market through this whole period as falling rates in reaction to the pandemic supported growth. But, starting in November of last year the investment landscape changed as the anticipated Democratic victory brought forecasts of larger government deficits and a stronger economy which drove interest rates higher. Value, being more economically sensitive took the market leadership and has maintained that advantage until this June when treasury yields continued to drop from their March peak of 1.74% to a low of 1.25%. Since that peak in rates, the market has essentially flat-lined while growth has recently regained its leadership. During this period, growth is up 4.4% while value has slipped -0.8%. However, year to date through May, value still prevailed at +16.6% vs +7.8%.

In the second half, I would expect the themes to continue to rotate, but I would also expect the general market environment to be a little less friendly. In the second quarter, things were as good as they are going to get. Earnings and economic growth peaked along with government stimulation. The market will focus on what we refer to as the second derivative, which is the growth rate from one quarter to the next. So, earnings may be up 60% in Q2 but are projected to be up only 23% in Q3 and 17% in Q4. A declining rate of change, but still quite strong by historical standards. Nonetheless, the growth rate is slowing. Furthermore, a strong economy will require funding at potentially the same time as the Fed starts to contract liquidity. Financial instruments are generally the source of those funds which withdraws support for the market. Finally, the threat of tax rate increases next year could threaten significant fiscal drag as government spending proposals get watered down which would again be quite a contrast to the first half of this year. Historically, we’re following a fairly traditional pattern where monetary and fiscal policy are quite stimulative in the first year of a Presidency and then fall going into the second year, which is consistent with a market correction.

This combination of stretched valuations, peak economic growth, declining commodity prices and a Fed on the verge of becoming more restrictive provides an interesting but negative contrast to what we saw in the first half of this year.


As the title of my commentary states, I agree with the consensus view, but only up to a point. The economy, inflation and earnings growth are as good as they are going to get and will diminish or transcend in Fed speak. But, I don’t think we’re going to regress back to pre-Covid levels and that the residual economic strength will result in an inflation level above the Fed’s expectations. Will the Central Bankers react to this or will they be compromised by political influence? I don’t know. Furthermore, given the enormous amount of corporate and sovereign debt outstanding, can the Fed even use traditional interest rate increases as an antidote for inflation? If not, it will fuel a secular shift in investments to an inflation hedge type of strategy. For sure, any attempt to stem inflation with monetary policy will be met with a negative reaction by the financial markets, which has normally caused the policymakers to back off and certainly today’s collection of politicians and bankers stands in contrast to the Reagan/Volcker era which was prepared to do what was necessary to preserve some fiscal and monetary responsibility. The current Fed is not a guardian against inflation, but instead a proponent of it. ‘Group think’, low interest rates, debt monetization and massive borrowings not resulting in inflation has resulted in a re-appraisal of traditional economics. Structural forces are seen to replace traditional paradigms, and this has allowed monetary policy to go beyond stabilizing the business cycle to underwriting political social agendas under the excuse of a pandemic.

Although I do expect the market to work its way higher, I think investors are going to have to be a little more astute as to what they invest in. I don’t think the general market averages will provide a rising tide to make index investing attractive. But, I do believe equities, even with a market correction, which is overdue, will be the best asset class to protect your wealth.

Gerald R. Connor

Grant’s Interest rate Observer
Deutsche Bank Research
Apline Macro

Rosenberg Research
Yardeni Research
Ned davis Research
John Aitkens

J.P Morgan

Q2 2021 Strategy & Market Reviews

Each quarter, our Investment Management teams publish their key observations and portfolio updates across Global Equity and Fixed Income markets. This is a summary of our views for the Second Quarter of 2021. You can download the full reports HERE, or via the links shown below.


Last quarter, we described the economy as “smoking hot,” the markets were strong and we wondered whether we were likely to see a temporary pullback that would allow corporate earnings to catch up with rising stock prices, or an upward revision of the already-rosy earnings outlook. 

The verdict is now in. In the latest quarter, the S&P 500 advanced more than 8%, while the consensus earnings outlook rose by almost 11%. In other words, the economy remains smoking hot, yet the market is actually a little less expensive today than it was 90 days ago, at least relative to expected earnings.

The Federal Reserve (The Fed) increased its real GDP growth targets from 6.5% to 7% for 2021, unchanged for 2022, and up from 2.2% to 2.4% for 2023. We think this may provide a positive set-up for further earnings acceleration. Looking at the interplay between corporate earnings and stock prices over the past 50 years, this could prove quite positive for the market if history repeats itself.

The Fed also said that it expects inflation to peak at 3.4% this year before trending back to just above 2% in 2023. While this higher inflation was portrayed as transitory – and many of the underlying components, such as used vehicles, auto rentals, airfares and lodging are probably transitory – it is also possible that a reacceleration in employment and wage gains may not be so transitory. Time will tell.

In our view, given the strength of the economy and the strong outlook for earnings, and provided that interest rates remain low, it makes sense to continue to own equities. 


Peter Jackson, HBSc, MBA, CFA

Chief Investment Officer

Portfolio Manager, North American Equities

During the quarter, our overall equity exposure increased from 94% to 97%. Our US equity exposure remained flat at 48% while our Canadian exposure increased by 3% to 49%. Investors who follow our North American Plus International Strategy will have a higher allocation to international equities, which means their US and Canada weights will be proportionately lower.

We have continued to position the portfolio toward value-oriented stocks to benefit from the current economic recovery. These make up about 57% of the portfolio. Our allocation to growth stocks, which is typically less dependent on economic trends, is up slightly to about 35%. Staples, which we don’t classify as either growth or value, make up the balance.

Our allocation to Canada, which has predominantly value-oriented positions in sectors such as Financial Services, Consumer Discretionary, Industrials, Energy and Materials, has risen significantly since June 2020, from 40% to 49%. In parallel, there has been a decrease in US equity positions from 55% to 48%, comprising sectors such as Information Technology, Communications Services and Health Care.

We added one new position in the second quarter of 2021:

Topaz Energy is an oil and gas royalty company that takes a small (2-3%) royalty on each barrel of production on its acreage. Since it doesn’t have to commit any capital to exploration, free cash flow margins are very high at about 90% and can easily support a 5% dividend with a 65% payout ratio. Beyond the dividend, we believe upside will come from volume growth on their acreage and leverage to an improving natural gas price.


Phil D’Iorio, MBA, CFA

Portfolio Manager, Global Equities

Global stock markets continued to rise during the second quarter, with the S&P 500 increasing by 8.2% and the MSCI World Index rising by 7.3%. On a year-to-date basis, the S&P 500 is up 14.4% and the MSCI World Index is up 12.2%. The year-to-date return for the S&P 500 is the second-best start to a year since 1998.

The global economic recovery is most obvious in the United States where the vaccine rollout is at an advanced stage. The US economy is growing fast, jobs are being added at a strong pace, and US consumer confidence recently hit its highest point since the pandemic began.

The last 15 months have been very generous to global equity markets. While we anticipate an ongoing recovery for the global economy, we are mindful of the risks – including the potential for a period of market consolidation, inflationary pressures, and new COVID variants.

So how should investors position their portfolios given the current backdrop? We believe that as we have said earlier, investing in high quality companies is the best way to protect our portfolios. High quality companies are characterized by strong pricing power and stable cash flow generation. This allows them to pass rising input costs along to customers, while insulating them from the higher interest payments associated with rising interest rates.

While we expect stock market gains to moderate from the robust pace of the last 15 months, we do believe that we remain in a secular bull market and as such, our portfolios are very well-positioned for this environment.


Diane Pang, CPA, CA, CFA

Portfolio Manager, Fixed Income

Canada made major progress in vaccinations during the second quarter of 2021 with roughly two-thirds of the population now having had one dose and more than 30% fully vaccinated. Double vaccinations in the US have plateaued at around 47% of the population as reopening is in full swing.

Amid this progress, as we indicated earlier, stock markets continued to set new highs. Bonds told a bit of a different story, however, at least in part because central banks are still intervening with quantitative easing and yield curve control, which is keeping yields low.

The Bank of Canada’s most recent Monetary Policy Report was highly optimistic, which may have hinted at a rate hike as soon as late 2022. This possibility hinges on a number of assumptions, including smooth sailing with COVID and federal fiscal stimulus, sustained higher oil prices, a strong CAD/US exchange rate, and no major supply issues in areas such as lumber and microchips. We believe that any of these assumptions could disappoint on the downside.

The Canadian Bond Universe Index now yields 1.72%, which is unchanged from last quarter. We target a considerably higher yield for our clients. While the bond market spent the quarter in somewhat of a limbo, we were proactive in looking for opportunities and locking in yield where it makes sense.

Many onlookers want more from bonds than the current yield, but we remain patient. Our strategy is not predicated on having high volatility from which to derive our fixed income total returns. Actually, our preference is to be well-positioned for higher volatility to maintain stability, while we take advantage of less volatile periods to clip or earn decent levels of income from interest and distributions.

Many onlookers want more from bonds with yield, but we remain patient. Our strategy is not predicated on having high volatility from which to derive our fixed income total returns. Actually, our preference is to be well-positioned for higher volatility to maintain stability, while we take advantage of less volatile periods to clip or earn decent levels of income from interest and distributions.

Sustainable Investing at Cumberland

Almost without exception, our clients’ primary objective is to produce positive, tangible outcomes, such as growing and preserving their wealth over generations, or stewarding the assets of a charitable foundation or non-profit organization. However, in recent years, a secondary objective has been prioritized: investing in a manner that is sustainable for our planet and its people for the decades that lie ahead.

At Cumberland, we are pleased to share that our proprietary investment process delivers on both of these sets of important objectives. Our range of investment strategies have produced attractive risk-adjusted returns through decades of positive and negative market cycles, while also scoring well in terms of environmental, social and governance (ESG) sustainability measures.

A record of sustainable performance

Based on data derived from Sustainalytics, a recognized leader in sustainability research, the six core investment strategies managed by Cumberland Private Wealth Management scored higher than their respective benchmark indexes in terms of ESG as of the first quarter (Q1) of 2021, Sustainalytics’ absolute and relative ESG scoring*.

Below is a summary of the results of Q1 2021 ESG Relative Scores of Cumberland’s core investment strategies vs. their respective benchmarks, which are well above these proxies.

Sustainalytics ESG Aggregate Percentile Rank Scores
Cumberland’s Portfolio Strategy vs. its Benchmark – At March 31, 2021

For example, over roughly five years since June 30, 2016, our North American Plus International Equity strategy scored favourably relative to its Benchmark Index as can be seen in the chart below.

High 5 Year ESG Score*
North American + International (NAPI) Equity Strategy vs. Benchmark*
June 30, 2016 to March 31, 2021*

Measuring our performance relative to each strategy’s respective index provides valuable context: comparing risk and return, validating the contribution of our active management and proprietary, disciplined investment process, and benchmarking the sustainability of our portfolios.

At the same time, we remain highly aware of the risks intrinsic to indexes, including stock and sector over-concentrations and valuation bubbles. Ultimately, our North Star is measured in absolute return terms, premised on whether we manage our various portfolios’ risk adequately and capture growth in a manner that achieves our clients’ investment objectives for the long term.

Investing in sustainable companies

What makes our strategies more sustainable than the broader global investing universes or indices? The short answer is the high quality of the companies in which we invest, resulting from our proprietary investment
process and disciplined approach.

Today’s business leaders operate in an environment that is more competitive and transparent than at any time in history. These leaders are held accountable by the evolving expectations of shareholders globally, the scrutiny of regulators, employees and customers, as well as a growing class of stakeholders that can include everyone from activists and whistleblowers to citizen journalists and Twitter pundits.

In this environment, sustained success demands extraordinary vision, experience and discipline. At Cumberland, we screen thousands of public companies every year based on a process that has been honed over decades. We study numerous qualitative and quantitative factors to identify companies that have achieved a clear advantage over an extended period of time.

Qualitative and quantitative factors we study and prioritize

Leadership track recordReturn on invested capital
Business modelReturn on equity
Competitive moatReturn on assets
Secular tailwindsFree cash flow

The result is a diversified portfolio of some of the best managed companies in the world. Their leadership teams understand more than just how to make money. They are attuned to their stakeholders, they take a forward-looking stance and they are strategic in their approach to business as a force for good. Many are industry leaders in terms of sustainability who tackle material issues head-on, so it should come as no surprise that they score highly on ESG measures.

Positioned for a sustainable future

Our investment process has served our clients well over more than two decades since Cumberland was founded. From our top-down asset allocation strategies to our bottom-up security selection, our portfolios are built for the long term.

While specific ESG policies and set criteria have not been integrated into our investment process at this time, we invest in portfolios of carefully selected companies with strong, forward looking leadership teams and track records of performance as we described earlier – and in charting the past several years of ESG data, we are proud to see that our investment strategies have grown steadily more sustainable. We expect this trend to persist as we, among other investors around the world, keep harnessing these forces. We believe our clients will remain well-positioned to participate and benefit from investing in a more sustainable future.

Rebirth of The Gen X Tech Stock

Levon Barker

Microsoft was born in 1975 and went on to become one of the most powerful and profitable companies in history.

Five years ago, it looked like the company’s glory days might be over. Their personal computing business was down 5% and their cell phone division was going broke.

Yet, between 2016 and 2021, Microsoft doubled the growth of the broader stock market.

Watch Portfolio Manager Levon Barker explain the story of rebirth that most analysts missed, and why he believes Microsoft will continue to grow beyond expectations.

Year End and Q4 2020 Strategy & Market Reviews

Each quarter, our Investment Management teams publish their key observations and portfolio updates across North American, Global and Fixed Income markets. This is a high-level summary of our views for the Year Ended and Fourth Quarter of 2020. You can download more detailed reports below.


A century ago, with no vaccine, the Spanish Flu killed an estimated 50 million people. Today, with 1.8 million dead from COVID-19, we have two vaccines approved and finally some light at the end of the tunnel. One can hope that history will repeat itself and usher in a new “Roaring Twenties.”

2020 was a rollercoaster. Global stocks, represented by the MSCI World Index, lost more than a third of their value early in the year, only to gain nearly 70% and reach a new peak in December.

Returns were dispersed by region and industry. Tech stocks drove the Nasdaq Composite Index up 43.6% for the year. The S&P 500 (+16.1%) and MSCI Emerging Markets Index (+15.8%) also saw big gains. Canada’s TSX Composite Index returned 5.6%, while the FTSE 100 Index in the United Kingdom (-14.3%) and CAC 40 in France (-7.1%) lost ground.

The economic declines and job losses of 2020 were the most severe since the 1930s. Yet, thanks largely to government stimulus, US disposable income actually increased, defaults in the banking system were minimal and economic activity recovered quickly.

We are now witnessing a classic inventory-restocking cycle as manufacturers respond to consumer demand, which is back to pre-COVID levels. Much of this demand is for durable goods like cars and housing-related items – spending decisions that are longer-term in nature, difficult to reverse and generally a sign of strong consumer confidence.

We predict a strong global economic recovery in 2021 with one important caveat: The vaccines must work as advertised. Effective vaccines combined with low interest rates, ongoing stimulus, and huge pent-up consumer demand should drive a rebound that becomes increasingly obvious as the year progresses.


We maintain a “barbell” strategy, blending companies that are more and less sensitive to economic growth. This allows us to play both offense and defense as events unfold.

We added four new positions in the final quarter of 2020:

Analog Devices, a circuit and semiconductor manufacturer, has exposure to the growth of industrial automation and autonomous and electric vehicles.

Intuit, a provider of business and financial software, stands to benefit as people and businesses increasingly turn to online tax filing and accounting.

Morneau Shepell, traditionally a pension consulting company, owns a hidden gem in the form of a fast-growing online employee wellness service.

Sherwin-Williams, the paint company founded in 1866, operates a growing network of 4,900 stores that generate very attractive returns.


We recently added a position in Schneider Electric, a global leader in electrical management and automation. The company is well positioned to help address one of the world’s biggest challenges. Over the next 40 years, energy consumption is expected to grow by 50%, yet there is a goal to cut carbon emissions by half to address global climate change.

We also added positions in Analog Devices, Intuit and Sherwin-Williams, as did the North American portfolio.

We believe the Canadian dollar is likely to appreciate over the next 6-12 months, and implemented a 30% hedge against the US dollar during the quarter.


With the overnight interest rate at 0.25%, many are wondering when the Bank of Canada will announce a rate increase. 

In order for that to happen, the Bank will look for a significant improvement in unemployment along with inflation stabilizing at around their 2% target rate. Taking these factors into account, we believe rates will remain unchanged in the near-term and could even be cut to 0% if the pandemic is not brought under control.

In this environment, we continue to cautiously seek opportunities with a focus on preserving capital and managing risk.

‘Tis The Season

Phil D’Iorio

The Holiday season is around the corner and it couldn’t happen at a better time. A little rest and relaxation are much needed after the crazy year we have all been through!

The year started off on a positive note with the global economy in acceleration mode and global stock markets performed well out of the gate. However, by late February COVID-19 headlines created a panic that caused the S&P 500 to fall by 34% over a one-month period. After the panic subsided, stocks surged with global equity markets rising by more than 60% from the March lows.

After an unprecedented year, we hope that 2021 will represent a return to normalcy or at least something more normal than 2020. Taking a trip, eating at a restaurant, and getting together with friends & family would be nice. A return of diplomacy may also be welcomed. With Joe Biden as President, the United States should see the return of a steadier hand in the White House with a more multi-lateral approach towards foreign policy.

As 2020 nears an end, investors face several crosscurrents. On the positive side, the US election has passed with a market-friendly outcome and COVID-19 vaccines are in the process of being distributed. This type of backdrop would typically be the all-clear signal investors need to shift out of defensive work-from-home beneficiaries and into more cyclical investments. However, major developed countries across the Northern Hemisphere are facing new record levels of COVID-19 infections. This has led to a new round of economic lockdowns. It also increases the risk that some companies might not make it to the other side of this pandemic. More stimulus would help so let’s hope that recent stimulus discussions are finalized sooner rather than later.

Looking ahead to 2021 there is a consensus view that the world will stage a strong recovery. Several economists are forecasting real GDP growth of 5.0% to 5.5% for the global economy. This would represent the fastest level of growth since the 1980’s. As long as the vaccines do their job and people are willing to take them, we believe that the consensus view is achievable. Under this scenario we would expect a continuation of the rotation towards more cyclical areas of the market and better returns from the laggards as COVID losers stage a recovery. If the consensus view materializes, it should be a good year for the stock market and it would feel rewarding given what everyone has been through in 2020.

This will be our last note of the year so thank you for reading.

Happy Holidays and I wish you a healthy and prosperous year in 2021!

November – A month of Thanksgiving and a month to give thanks

Phil D’Iorio

November was a great month for many reasons. Not only were global equity markets exceptionally strong, but we also received promising news on 3 separate vaccines with very high effectiveness rates in the 90%+ range. It has been a challenging year but there is light at the end of the tunnel!

During the month of November, the MSCI World Index was up 12.7%. The MSCI World Index is a very broad index which includes more than 1,500 companies across 23 developed markets so it’s a great proxy for what’s going on in global stock markets. The 12.7% gain did not break the all-time monthly record, but it’s pretty darn good when you consider that it’s a larger return than what is typically generated over a 12-month period! The pan-European Stoxx 600 index, meanwhile, notched its best-ever month in November, ending 13.7% higher. The major U.S. indexes also generated strong returns in November with the S&P 500 rising 10.8% and the Dow Jones Industrial Average gaining 11.8%. This was the largest monthly gain for the Dow Jones since 1987. Technology stocks also had a great month with the Tech-heavy Nasdaq Composite Index rising 11.8%.

So after an amazing month, what are we going to get for an encore? While nothing is guaranteed, history does paint an encouraging picture. Over the last 60 years, periods of strong market gains have often been followed by further gains as seen in the chart below. According to LPL Financial, following a 10% monthly gain, the S&P 500 is up 83% of the time 6 months later by an average 11.5%. On a 12-month horizon, the S&P 500 is up nearly 82% of the time by an average 13.1% following a monthly gain of 10%.

Over the last 8 months stock market returns have been so strong that they have surpassed the expectations of almost every expert on Wall Street and Bay Street. How can we put this into perspective and how can it be explained? Nobody has the exact answer, but from our vantage point the strong gains can be partly explained by a forward-looking stock market and sidelined cash getting put to work. Notwithstanding a major shock or a vaccine failure, the global economy is set for a significant recovery in 2021 and so the market has strengthened in advance of the recovery. In addition, it also looks as if investors who sidelined trillions of dollars of cash have grown tired of making modest returns in money markets funds and have decided to move into equities.

Following this huge advance in global equity markets, a common question we now hear is “is it too late to get in?”. The answer of course, is, it depends. It depends on who is asking the question, their tolerance for risk, and their investment time horizon. From our perspective, we see an economic recovery and the potential for a sustainable economic expansion driven by a synchronized global recovery.

But what about valuations? Stocks look expensive on several measures that compares them with their own sales, book values, or earnings. However, the yields on U.S. Treasury bonds hit an all-time low earlier this year and remain at levels that most experts would not have predicted 5 or 10 years ago. All else equal, lower interest rates should justify paying more for stocks given that equities can be discounted at a lower rate, making them more valuable.

Recent findings by American economist Robert Shiller shed some light on this subject. Mr. Shiller is well respected on Wall Street given that he famously predicted the Technology meltdown in 2000. He also predicted the 2007 stock market decline that was triggered by the crash in US housing. In a recent publication, Mr. Shiller discusses the surprising resilience of global equity markets in the face of the COVID-19 pandemic. In his piece, he suggests that perhaps investors shouldn’t be so surprised by the market’s resilience. In his opinion, a close look at a measure he calls the Excess CAPE Yield (ECY) puts the long-term outlook for global stock markets in better perspective. The Excess CAPE Yield measure is a useful way to think about long-term valuations for stocks in way that also incorporates the current level of interest rates.

To calculate the Excess CAPE Yield (ECY), one must take the inverse of the cyclically adjusted PE ratio to get a yield and then subtract the ten-year real interest rate. A higher measure indicates that equities are more attractive. The ECY in the US, for example, is 4%, derived from a CAPE yield of 3% and then subtracting a ten-year real interest rate of -1.0%.

According to Mr. Shiller, the Excess CAPE Yield has typically done a good job of predicting subsequent returns over the following 10 years. As seen in the chart below, the Excess CAPE Yield in the US is just slightly below the average of the last 100+ years. According to Mr. Shiller, this suggests that U.S. stocks should generate real returns of approximately 5% per year over the next decade.

Source: Bloomberg

Outside of the US, Mr. Shiller found some very striking results. The Excess CAPE Yield is close to 40-year highs across several global regions and is at all-time highs for both the UK and Japan. The Excess CAPE Yield for the UK is almost 10%, and around 6% for Europe and Japan. China’s ECY is at about 5%. All of these figures indicate that worldwide equities are highly attractive relative to bonds right now.

Another measure that suggests that equities are attractive is the price-to-free cash flow measure. Free cash flow is one of the key determinants for valuing stocks so this is a highly relevant measure. As seen in the chart below, the price-to-free cash flow ratio has averaged 25.8x over the last 35 years. This ratio is currently sitting at 22.8x, which implies that the current price-to-free cash flow ratio is 11.6% below the average of the last 35 years.

Taking everything into consideration we remain cautiously optimistic as we approach the end of 2020 and as we look ahead to 2021.

Have a good weekend,


“Buy low/sell high” is tough when you’re not sure which way is up

It’s probably the first adage one ever hears about investing which sounds easy enough. But in the rapidly shifting world of the markets, buying low and selling high isn’t nearly as easy as it appears.

When markets are down, investors believe that risk is elevated. In fact, risk is reduced since the ‘sold-down’ markets include a “fear premium” or discount -prices drop as events happen not after they occur, investors shouldn’t fear further losses once prices have hit bottom. Another adage, “If it’s in the press, it’s in the stock price”, rings true.

When the markets react, a move up or down factors in the past. Environments investors perceive as risky and volatile are less risky because prices have already dropped and will rise again as history reveals.

To execute, one needs knowledge and experience to recognize when a market move is just a temporary ‘blip’ that’s here today and gone tomorrow, versus when it could be the first reverberations of a trend for the months, possibly years ahead.

Knowing what to look for and having the skill and confidence to select opportune investments are two different things. Younger generation investors may be unsure, but those who have gone through the tough times and understand the paradox of investing, will be able to both pull the trigger and recognize danger signs.

Regardless, investing in the market requires a solid plan. All investors need to understand their end goals, the risks they can take and go from there with a team of active managers on their side.

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