How fiscal stimulus and pent-up demand is fueling the economy.
From the market lows of March 2020 to the record highs now in play, there’s good reason for optimism for the rest of 2021. The second quarter started off with a bang as the S&P 500 flew past the 4,000 mark, and the S&P/TSX Composite Index surpassed 19,000 — another record. New manufacturing statistics also indicated that a strong recovery is well underway. March data from the Institute for Supply Manufacturing marked a 37-year high for manufacturing growth.
“Things are playing out nearly exactly as we predicted, validating the rapid reopen thesis created by the Capital Markets Strategy team,” says Philip Petursson, Chief Investment Strategist, Manulife Investment Management. “We’re seeing continuous growth in commodities; vaccination programs are now fully deployed across North America, Europe, and elsewhere; and overall, things are trending in the right direction.”
The rapid reopen thesis, published earlier this year, supported the notion that strong economic growth was more than possible because of a few key developments:
- COVID-19 vaccine rollouts would provide a level of confidence for economies to reopen.
- Pent-up consumer demand would see a flood of savings enter the market.
- Production would increase as businesses scrambled to replenish depleted inventories.
“My view is that with all the fiscal stimulus slowly working its way through the economy, there’s a pent-up demand among consumers — whether it’s buying sports equipment, dining out, or sprucing up living spaces. It might be surprising for many to see just how strong the economic rebound can be for the rest of this year and into next year. In addition, there’s very little evidence of a recession in the next 12 months, and the outlook for equities has positive momentum,” says Philip.
The strength of the market rebound is a welcome boost of confidence as energy and manufacturing sectors see expansion, offsetting tourism, hospitality, and food service sectors, which continue to struggle through the many pandemic restrictions.
The quick rise in early March of U.S. benchmark crude futures to US$66 a barrel came faster than expected. “At the beginning of the year, our target for oil was US$45 to US$55 for the year, which we blew right through very quickly,” says Philip.
“The anticipation is that oil will likely move higher, along with the markets in general,” says Kevin Headland, Senior Investment Strategist, Manulife Investment Management. “There’s a pent-up demand coupled with an incredible production backlog as manufacturers continue to ramp up and get back on track after shutdowns. And this is positive for future earnings growth.”
While the continued strong market growth is welcome news, it does bring with it the expectation for inflation to remain above two per cent through the rest of 2021 — a topic that Macan Nia, Senior Investment Strategist, Manulife Investment Management, cautions requires some perspective, given commodity price increases.
“You have to consider the wide-reaching need for oil. It’s not just to drive your vehicle, it’s a base ingredient for the shingles on your roof, the paint on your walls, the PVC pipe that makes up a lot of plumbing. Also, consider the effects of skyrocketing lumber prices, which is nearly 50 per cent higher than what it was a year ago. Copper is another — 30 per cent higher than it was nine months ago. Granite, insulation, concrete blocks, you name it; everything is more today than it was a few months ago,” says Macan. He adds that if we were to see inflation decrease, that would indicate a rollback in economic activity — a move in the wrong direction.
As economic growth improves and inflation increases, there’s an opportunity to revisit investment portfolios and consider adjustments that make sense.
A key indicator of consumer optimism is the surprisingly fast trajectory of the U.S. 10-year Treasury yield, starting the year at 0.91 per cent and ending the first quarter at 1.74 per cent. The 10-year Government of Canada bond yield gained 88 basis points to finish the quarter at 1.56 per cent. This video explains the significance of 10-year rates.
“When it comes to the bond market, some perspective is needed,” says Kevin. “10-year Treasury yield rates haven’t yet reached the pre-pandemic level — we're simply getting back to previous levels.”
The Capital Markets Strategy team model portfolio continues to maintain a balance of 65 per cent equities to 35 per cent fixed income, with a bit of adjustment on the equities side.
For illustration purposes only
Canada and emerging markets are two areas that have increased weight in the model portfolio. “When considering adjustments, it’s about evaluating the risk and considering what equities are sensitive to interest rate increases,” says Philip. “We’re steering away slightly from some of the interest rate sensitive sectors — such as overvalued tech, telecoms, and utilities — and turning more to energy, materials, industrials, and financial stocks.”
When it comes to fixed income, it’s all about defence. “You can’t predict corrections and it’s important to have the right setup,” says Kevin. “In this environment, you need flexibility to be able to move to the right type of bond to reduce risk, given the circumstance at that moment. Fixed income is part of a well-constructed portfolio.”
“It’s so easy to say buy the dip, but if you have nothing to buy the dip with, you miss an opportunity,” says Philip. “Even though there’s a good deal of market optimism moving forward, you never want to forget your bond defence against potential volatility.”
While it now seems to be a time of acceleration with commodity prices and bond yields moving faster than expected, the magnitude of this recovery remains difficult to predict. The Capital Markets Strategy team suggests a glass-half-full viewpoint — things are getting better even in the two-steps-forward, one-step-back reality of pandemic setbacks, reopening restrictions, and potential tax hikes.
“Regardless of what the pace is, we’re going forward in an environment that’s getting incrementally better, and that really should be a leading driver in portfolio construction decisions,” says Kevin.
“Remember to stay focused. Dollar-cost averaging, buying the dip, and staying invested is the right strategy for the long-term benefits,” says Macan.
“Never let uncertainty or fear drive investment decisions. That can lead to mistakes. For all those investors that sold in March 2020, they missed a 75 per cent run on the S&P 500, 67 per cent run on the TSX, a 75 per cent run on the Dow Jones Industrial Average, and a 95 per cent run on the Nasdaq, and that’s something you can never get back,” says Philip.
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