Between rampant inflation due to rising commodity prices, rising interest rates, companies issuing negative earnings guidance and the tragic situation in the Ukraine, there is a lot to be concerned about. We should probably throw COVID-19 in there as well although it’s now one of the further things in investors’ minds.
The good news, from a stock market perspective, is that returns were even better in 2021 than 2020. The bad
news is that as we write this family and friends are being exposed to and/or falling victim to Omicron, which
may have a basic reproduction rate (R-value) as high as 10, far exceeding earlier variants and second only to
During the second quarter of 2021, earnings rose almost 91% year over year, up from the 63% increase that was expected on June 30th. While this pace of earnings growth is clearly not sustainable, the outlook for the third quarter has continued to accelerate, which at the time of writing is 27.9% as compared to 24.2% at June 30th. The recent stream of softer economic data, seasonality and lack of any significant pullback in the market has created some level of investor trepidation and while a correction can never be ruled out, particularly since they are pretty common in secular bull markets, in an environment of strong earnings growth and practically zero interest rates we continue to think the outlook for equities remains positive.
During the second quarter of 2021, the S&P500 total return index was up +8.6% in US dollars. Adjusting
for currency, the S&P500 returned +7.0% in Canadian dollars, as the Canadian dollar appreciated about 1.2
cents, closing the quarter at US$0.807. The TSX total return in the second quarter was +8.5%, as can be seen
in greater detail in Appendix 2. The biggest performance driver was positive earnings growth in both markets.
While earnings were expected to be strong, actual earnings in the first quarter for the S&P500 rose 52.5%
year over year as compared to an expected gain of 23.7% at March 31st, far exceeding market expectations.
During the first quarter of 2021, the S&P500 total return index was up +6.2% in US dollars. Adjusting for currency, the S&P500 returned +4.9% in Canadian dollars, as the Canadian dollar appreciated about 1.0 cent, closing the quarter at US$0.795. The TSX total return in the first quarter was +8.1% Like the fourth quarter of 2020, the market was influenced by the prospect for a vaccine induced reopening of the economy and better than expected earnings. Supporting this were the recent March economic projections from the Federal Reserve (Fed) members, which show further strength in real GDP growth for 2021 and 2022, with the 2021 rate revised up 2.3% to 6.5% from 4.2% in December representing the strongest growth in GDP since 1983! Also, the unemployment rate was revised down for each year through 2023 once again approaching the pre-COVID low of 3.5% in February 2020, which already represented a 50 year low!
Meanwhile, Core Personal Consumption expenditure (PCE), the Fed’s preferred measure of inflation, is barely expected to rise above 2%, which gives the Fed plenty of cover to keep rates low. And notwithstanding these sharply ramped up forecasts for growth, somewhat higher inflation and lower unemployment, the Fed is still projecting no interest hikes in the forecast period through 2023. Some transitory inflation through the second quarter of 2021 is built into the Fed forecast as we lap lower prices last year due to COVID-19; however, it is not enough to cause a change in their 2021-2023 view.
As we discussed at our recent client quarterly presentation, we have taken somewhat of a barbell strategy with our large sector exposures split between what we consider offence and defense companies or growth versus value. In the current environment, it is important to position the portfolio to benefit from the economic recovery while not fully depending on it, so our current split between offence or growth stocks, which are typically more dependent on trends independent of an improving economy is about 38% versus defense or value stocks, which are more dependent on an economic recovery is about 49%.
In our March 31st Strategy Review, we attempted to show that even though things were really bad and were expected to get a lot worse in the near term in terms of number of Coronavirus cases and the shape of the North American economy, it appeared that, at least based on historical declines in price, forward earnings and forward price/earnings (P/E) multiples (ie. valuations), that a lot of the bad news was likely baked into the stock market. And from the lows of March 23rd, we have seen a tremendous rally in both the S&P500 and the TSX, up 34.5% and 35.3%, respectively.
We witnessed the S&P500 drop -33.9% from its February 19th high through to the low reached on March 23rd as the global coronavirus pandemic unfolded. While the news regarding the virus, and the spike in cases here in North America, is likely going to get a lot worse before it gets better, our sense is that the world is waking up and doing what it can to help prevent the spread until a vaccine or treatment is found.
This decade will be remembered for a few things. From a stock market perspective, it will not only be remembered as the longest bull market in history, but also the best performing decade in history. However, some strategists have also coined this the most ‘hated bull market in history’. That’s not necessarily a bad thing because if everyone had been in love with this market and fully invested, then who would be left to buy it? Let’s start by recapping where we were a year ago as compared to today.
At our recent investment meeting a discussion ensued about the fact that Elizabeth Warren had taken over as front-runner in the Democrats’ race for US president. I think the general consensus is that Trump will win again in 2020, but you probably would have said that about Hillary Clinton three years ago at this point in the race. A Warren President would likely mean higher taxes, more regulation and perhaps some form of Medicare for all. It would probably be the opposite of a Trump second term, meaning more uncertainty for the markets surrounding the electoral outcome.