We saw acceleration of digital transformation also consistent with this trend of the enterprise transformation of the home. So that’s driving a situation that demand is outpacing supply.
Cristiano Amon, President of Qualcomm in FY21Q1 earnings call.
If Fed Chair Jerome Powell was looking for hints that “people are confident that it’s safe to resume activities involving crowds of people”, he got a strong signal on U.S. Memorial Day as a crowd of 135,000 people gathered to watch the Indy 500 race. Life is normalizing fast in the U.S. and Canada is not too far behind. With the pandemic looking more in the rear-view mirror, investors have a lot less to worry about, besides the fear of seeing economic growth run too hot and causing a new inflation regime.
Global equities grinder higher in May as U.S. high-frequency economic indicators continued to point to improving growth (Source: Bloomberg). U.S. real Gross Domestic Product (GDP) growth for 21Q1 came in at 6.4% while Canada registered a 5.6% pace as economic activity is now higher than its pre-COVID-19 level. However, the healing of the U.S. labour market has a lot of room to run until employment fully recovers, which should leave policy focused on supporting growth with low interest rates and large fiscal deficits.
In Europe, the reopening is finally moving growth into recovery mode, especially in the U.K. where the return-to-normal is helped by an impressive vaccination campaign. While Western economies are making progress against the pandemic, many Southeast Asian economies recently faced a virus resurgence, which will hold back growth a little into the early part of the summer. We nevertheless expect global growth to move into a synchronized phase during the second half of 2021 and 2022, but peak growth will probably be reached before the Fall, yet we think it will remain far stronger than normal.
Global Markets: Global equities keep grinding higher
Global equities (MSCI ACWI, +1.6%) rose for a fourth consecutive month as the recovery from the pandemic is accelerating and broadening. Most major equity markets were up in May, led by Canada (S&P TSX, +3.4%) as energy and financials outperformed last month. In Europe (Eurostoxx, +2.3%), the region benefited from a strong outperformance of the most beaten indices in 2020 (France CAC 40, +4.0%; Italy MIB, +5.2%) as economic activity is finally starting to take off after extended lockdowns. U.S. shares underperformed (S&P 500, +0.7%) their global peers as mega-cap tech companies fell slightly in May (Nasdaq 100, -1.2%) while small-caps (Russell 2000, +0.2%) also flatlined. Emerging markets (MSCI EM, +2.3%) slightly outperformed even as Chinese shares (MSCI China, +0.5%) faced headwinds from greater political scrutiny over large tech companies. Finally, Japanese (Nikkei, +0.2%) shares were flat as the country struggled with the resurgence of the virus and rising commodity prices weighed on its currency.
North American long-term interest rates were little changed in May, although fixed-income markets traded anxiously around major U.S. data releases such as jobs and inflation reports. The yield on Canada’s 10yr bond ended the month at 1.49%, down a small 6 basis points (bps) form April. Oil prices drifted higher to $66.32 Barrel of oil (Bbl) (from $63.58) as the reopening of the economy remains a tailwind. After a sharp increase in recent months, lumber prices eased a bit to $1309/per-thousand-board-feet, still well above the $400 range seen in 2019. Rising global optimism weighed on the U.S. Dollar (DXY, -1.6%). The loonie also benefited from the broad USD weakness and gained 1.9%. Finally, the VIX volatility index fell to its lowest level (16.8%) since December 2019 as the fog around the outlook dissipates.
Global Equity Factors: Style rotation extends on improving optimism
Equity style performance continued to perform within a tight range as the reopening tide is lifting the broad equity market in 2021, with equity volatility also reverting to a more benign level and interest rates stuck in a tight range. 2020 laggards such as Value (+3.1%) and High-Div (+2.9%) continued to outperform in May, while 2020 winners (Growth, 0.0%; Momentum, -1.2%) lagged last month, whereas the other main equity styles had performance similar to the broad global equity benchmark (AWCI, +1.6%). Until we reach peak growth optimism, some of the recent equity-style performance could extend further.
Within Canadian equities, Low-Vol stocks (BMO Canadian Low-Volatility Equity ETF, ticker: ZLB, +2.8%)* slightly underperformed the broad BMO S&P TSX index (ticker: ZCN, +3.6%)** as the highly cyclicals segments (energy and banks) of the market outperformed.
Canadian Dollar Outlook: Rising along global reflation, on overdrive thanks to a hawkish BoC
After a rough ride during the peak of the pandemic, the loonie is the best performing major currency against the U.S. Dollar this year. For decades, the main two factors impacting the value of the Canadian Dollar are oil prices and the interest rates differential with the U.S., proxied with the 2-year notes, whereby rising oil prices or rising relative interest rates makes the Canadian Dollar more attractive vs the USD. Given where oil prices and interest rates are, our fair-value models suggest the Canadian Dollar is fairly valued.
Although the loonie appears to be fairly valued and performing in line with the global reflation wave, our optimistic outlook calling for global synchronized growth that sees more upside for equities and commodity prices, and a declining USD, implies a positive outlook for the loonie. Moreover, the faster-than-expected economic recovery in Canada is likely to get the Bank of Canada to bring forward rate hikes, perhaps even by early 2022, while the Fed could be more patient, which should benefit the loonie.
Our thesis since last summer has been to expect better and more lasting upside from equities than in the Canadian Dollar, and between April 2020 and May of this year, global equities (MSCI ACWI) climbed 61% whereas the loonie only rose 17%. We continue to prefer to play the global reflation by overweighting equities versus fixed income, rather than play on currencies. However, our positive outlook for the Canadian Dollar is partly why we are overweight Canadian equities vs EAFE (Europe, Australasia, and the Far East), whose currencies should continue to face headwinds from commodity reflation.
Digitalization and U.S. Consumption Binge Causing Supply Shortages
Supply shortages continue, keeping fears of high inflation alive and well. U.S. consumers are the driving force, in our view, reflecting pent-up demand and wealth effects from stimulus payments and higher home and stock prices. When U.S. consumers have money to spend, imports tend to pick up, driving global trade. Soaring U.S. import volumes continued through March, led by consumer and capital goods and helping to drive strong global trade flows. Asian export data reveals broad demand within electronics, from consumer to industrial goods, with the greatest impact on the semiconductor industry—an industry that is usually under-supplied and prone to boom-bust cycles in prices (Source: Economist). Booming global trade and strong U.S. demand suggest that the problem with supply shortages is strong demand, rather than supply chain disruptions.
The Port of Los Angeles, which processes 40% of the world’s containers, saw a surge in inbound containers in Q1, coinciding with U.S. reopening and stimulus top-ups. We think clogged supply chains will alleviate this year as the global economy vaccinates and reopens but could extend into 2022 as capex takes years to respond even if planned, notably in industries like semiconductors. Indeed, the U.S., Asia and even Europe are taking steps to expand capex in the tech sector ($180 billion for tech spending under Biden’s plan, $100 billion planned by Taiwan Semiconductor Manufacturing Company (TSMC) (Source: Bloomberg), large annual increases in Research and Development (R&D) spending by China). Other temporary factors that also explain why supply is having trouble meeting high demand are precautionary stockpiling by Chinese firms in response to U.S. sanctions as well as weather-related disruptions.
More importantly, we believe shortages are temporary because consumer spending will normalize from lofty levels later this year as wealth effects fade and unemployment benefits cease after September. This should cool spending on goods, particularly big-ticket items like cars. A broader return to the office will also shift spending away from electronics, homes and other work-from-home items which saw demand boom during the pandemic. As a result, input price pressures stemming supply shortages are likely to cool as well, keeping any passthrough to consumer prices (albeit low to begin with) well contained (see our latest piece, (Source: BMO GAM).
Outlook and Positioning: Staying the course on the recovery
Our portfolio positioning is unchanged this month as recent earnings and economic data confirm our medium-term investment thesis where we expect global equities to rise largely in tandem as the pandemic gradually becomes a thing of the past. While we expect short-lived episodes of market volatility around sensitive economic reports (jobs, inflation) that could impact the Fed’s policy stance, we think the Fed will continue to only crawl in adjusting its policy outlook in order to avoid causing some tantrum.
* The performance for (ZLB) for the period ended May 31st, 2021 is (as follows: 28.41% (1 Year); 11.42% (3 year); 9.71% (5 year); and 13.04% since inception (on October 21st, 2011).
** The performance for (ZCN) for the period ended May 31st, 2021 is (as follows: 33.82% (1 Year); 10.53% (3 year); 10.30% (5 year); 6.71% (10 year); and 7.91% since inception (on May 29th, 2009).
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