October 8th, 2021

Q3 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 Third Quarter of 2021. You can download the full reports via the links shown below.


Another quarter, another big stock market gain. The S&P 500 rose 3.4% in Canadian dollar terms, with positive earnings growth once again the main performance driver. While earnings were expected to be strong, the 91% year-over-year increase far exceeded estimates. In fact, 87% of S&P 500 companies reported positive earnings surprises, which is the highest percentage since 2008.

In a divergent trend, some key economic indicators, including the Purchase Managers’ Index, jobs data and the latest inflation figures cooled somewhat. This fact, combined with some seasonal choppiness in stock prices, has led to the market trepidation many are currently feeling. The question is whether this will become a material headwind to earnings and share price performance.

For clues, we periodically calculate the implied future earnings of the market based on bond yields and equity risk premiums, and compare that to the consensus earnings estimates. We currently find that the implied earnings are about 5.7% below the estimates, suggesting that the market has actually become a little cheaper over the past nine months and has continued upside potential.

Declining US inflation between June and August lends credence to the view right now that higher inflation is transitory. As investment analysts, the disconnect is that we hear about inflation concerns from companies almost daily. The good news is we think most of the companies we own are successfully passing rising costs through to their customers. In fact, this appears to be the case for the majority of companies in the S&P500 index.

The recent stream of softer economic data and lack of any significant pullback in the market has set some investors on edge. While a correction can never be ruled out, particularly since they are pretty common in secular bull markets, in the current environment of strong earnings growth and practically zero interest rates, we continue to believe the outlook for equities is positive.

Peter Jackson, HBSc, MBA, CFA

Chief Investment Officer

Portfolio Manager, North American Equities

During the quarter, our exposures remained virtually the same at 47% US equity, 49% Canadian equity and 4% cash. It is important to note that many of our clients’ portfolios are invested in our North American plus International Equity strategy, meaning that the actual weights of US and Canada will be proportionately lower by about 20% given the approximate 20% allocation to international equities.

We have continued to position the portfolio toward value-oriented stocks to benefit from the economic recovery, while maintaining exposure to growth stocks for about a third of the portfolio.

During the third quarter, we added to our energy and mining exposure by increasing our weighting in Topaz Energy (Topaz) and purchasing a position in ERO Copper Corporation (ERO Copper) on the off-chance that inflation does take a bigger bite out of the economy than we currently think. 

Topaz acquires royalty and non-operated energy infrastructure assets, and has 83% of its assets tied to the price of natural gas, which is trading at 5-year highs. Almost all of Topaz’ royalty production and processing revenue converts to free cash flow, supporting a sustainable dividend yield of 4.6%, which we believe can increase. Topaz expects a 17% compound annual growth rate of production over the next three years.

Having reached a threshold of almost $2bn in market cap and expanded its float recently, we expect Topaz to be eligible for index inclusion as early as December 2021, which would create more demand for the stock from institutional investors.

ERO Copper is a mid-sized copper and gold producer in Brazil whose management and board are laser focused on Return on Invested Capital, which is a discipline most global mining companies lack. Management and the board own approximately 16% of the company, which makes them highly aligned with shareholders like us.

Phil D’Iorio, MBA, CFA

Portfolio Manager, Global Equities

On a year-to-date basis to September 30th, the S&P 500 Total Return Index is up 16.8%, while the MSCI World Total Return Index is up 13.6% (in Canadian dollar terms). This advance has been driven by a global economic recovery and further progress with COVID-19 vaccinations.

Recent volatility can be attributed to concerns about peak economic and earnings growth, inflation, the US debt ceiling, Fed tapering, the Delta COVID variant, vaccine efficacy, China’s economic slowdown, Evergrande, and supply chain disruptions. While these worries may be warranted, volatile periods are normal and have historically been a good time to buy stocks given that most of the concerns prove to be temporary.

The underlying rationale for our overall positive stance on global equities is related to our expectation of an ongoing global economic recovery. On the supply side, we believe significant economic slack will be taken up as the economy returns to normal and production shortfalls are relieved. On the demand side, we believe consumers will return to restaurants, sporting events, concerts, hotels, and airports in droves.

In terms of the key risks, we put inflation near the top of the list. If inflation remains stubbornly above market expectations, it could have negative implications for the stock market. However, from our vantage point, inflation appears largely driven by transitory disruptions that occurred across global supply chains. Further, we see technologies such as automation, robotics and e-commerce acting as long-term counter-inflationary factors.

The companies that we own are profitable across the business cycle and generate strong free cash flow even during economic downturns. Given their leading market positions, our companies have strong pricing power which will help them if inflation remains persistent. 

In summary, we expect an ongoing recovery for the global economy and believe that our global and international mandates are well positioned to benefit from this recovery.

Diane Pang, CPA, CA, CFA

Portfolio Manager, Fixed Income

For the first two-and-a-half months of the third quarter, markets moved quietly and slowly in a positive direction. Towards the end of the quarter, things became more interesting as COVID-19 cases started to spike, the US ran up against its debt ceiling, and one of China’s largest real estate developers, Evergrande Group, faced hefty interest payments on its debt obligations.

In the US, Treasury Secretary Janet Yellen had estimated that the US would run out of money by October 18th unless action was taken to suspend or increase the federal debt limit. After some initial failed attempts, the Democrats successfully passed a nine-week stopgap funding bill that will kick the can a little further down the road to December 3rd.

Investors are watching and wondering whether China’s second-largest real estate developer, Evergrande, will be able to meet its pile of debt obligations. According to Bloomberg, eight of the world’s 10 most indebted property developers are based in China, and real estate/construction accounts for about 29% of China’s economic output. 

Reports say that Evergrande had 778 projects under construction in 223 cities and carried about USD$89 billion in debt borrowed from banks and bond investors The company appears to have bought some time by selling its stake in Shengjing Bank, but will need to complete some of its current projects in order to avert another crisis. Stay tuned.

During the quarter, the US Federal Reserve kept interest rates unchanged at 0%.The Canadian Bond Universe Index now yields 1.80%, but we target a yield above that for our strategies. With the prospect of central bank tapering in both Canada and the US, we believe there will be some volatility in the near future that will create opportunities to lock-in higher yields. We continue to operate and invest in a very patient manner.