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.

The latest quarter has been influenced by increasing market concern around protectionism as both the NAFTA trade issue came to a head and we saw the implementation of new tariffs on China. In any negotiation, there are usually winners and losers but when we compare the returns of the S&P500 over the past three months and year to date to Canada, or even globally, it feels like the S&P500 is in a “Heads I win, Tails you lose“ scenario.

No one wants to be a contrarian just for the sake of being one but right now it might pay to take advantage of the volatility. It feels like everyone involved in capital markets has turned more negative. While the investment outlook does feel a little less certain given the headlines on protectionist trade issues and foreign investment limitations on sensitive US technology that has resulted in a spike in volatility, volatility was at 20-year lows so some level of normalization should probably be expected. In Exhibit 1, we compare volatility as measured by the VIX, commonly referred to as the Fear Index, to high yield credit spreads (the interest rate demanded by investors in high yield bonds over similar maturity investment grade or government bonds).

The first quarter of 2018 seemed to have something for everyone involved in the capital markets. It started with a positive market reaction for the S&P500 in January from the US tax reform plan announced late in the fourth quarter of 2017, which drove some of the largest earnings increases for 2018 ever recorded in any quarter. The outlook for forward earnings growth for 2018 was 12% at December 31st and now sits at a whopping 19%. We then experienced one of the more anticipated market corrections in February, which was triggered by the sharp rise in bond yields resulting from the strong employment and wage data for January. In March we heard from the new Fed Chairman Jerome Powell who, as expected, raised interest rates a quarter of a percentage point marking the sixth rate increase since December 2015.

I can’t help but think back to a phrase I first heard in the early 1990’s, “the Goldilocks economy”, the reference is to the children’s story, The Three Bears. It best describes the current state of the US economy as being not too hot and not too cold or in other words an economy with moderate economic growth and low inflation. So far, it seems like everything is just about right. US GDP has continued to pick up through 2017 with the latest third quarter reading of 3.2% up from 1.2% and 3.1% in the first quarter and second quarters respectively. Inflation has remained in check notwithstanding the latest November reading of headline inflation, which climbed to 2.2% mostly due to rising energy prices. Excluding food and energy, core inflation is running at 1.7% and more importantly, the latest reading for the Federal Reserve’s (Fed) preferred measure of inflation, the Personal Consumption Expenditures (PCE), was only 1.5%, well below the Fed’s notional target of 2%. The other factor the Fed looks at in determining future interest rate policy is employment, which has remained solid so far in 2017 with the November unemployment rate at 4.1%, a 17-year low.

Even though the economies north and south of the border continue to muddle along, some economists are describing the current environment, particularly in the US, as one of the best in a long time. The combination of synchronized global economic growth, low inflation, a reasonably accommodative central bank and rising corporate earnings are quite a powerful combination that could keep this market going for a while yet. The final reading for US second quarter GDP ticked up to 3.1% from 3.0%. This would normally suggest a reasonably strong hand-off for the back half of 2017, although we may see a hit in the third quarter due to missing output caused by hurricanes Irma and Harvey. This may cause a bigger rebound in the fourth quarter as rebuilding and spending on reconstruction takes place.