Market Commentary - Q2 2021
Members of the Louisbourg investment team recap investment markets and some of our investment strategies in the second quarter of 2021.
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Equity markets performance summary
The roaring equity market amid a global pandemic continues! The second quarter offered strong returns to compound on top of what was a strong first quarter and a surprisingly strong 2020. As the economy continues to recover, investors are mainly debating if the inflation we are seeing is transitionary in nature or could persist further. We are therefore left to wonder if the monetary support that is fueling markets will leave faster than expected. This brings along a more balanced market with some attention shifting from long dated technology growth stories towards less expensive companies that should benefit from a cyclical upturn. Again this quarter, our domestic equities were the top performer for Canadian investors and smaller caps benefited the most. U.S. equities also performed strongly despite the headwind of an appreciating loonie. International equities lagged but still returned attractive mid-single digit returns for the period.
Canadian equities continued with their momentum as S&P/TSX Composite returned another 8.5% this quarter, which brings the year-to-date performance to a stunning +17.3%. Breadth across sectors was wide with ten of eleven sectors offering positive returns. Only the tiny Health Care sector was negative (-11%), while Industrials (0%) and Utilities (+1%) lagged the
benchmark notably. Technology (+23%) offered the strongest return for the period while Energy (+14%), Real Estate (+11%) and Communications (+10%) contributed nicely with double digit returns.
U.S. equities finished the quarter up 8.6% in USD, outperforming their international counterparts as faster vaccination rates and stimulus led to higher expectations for the recovery. The strength of the loonie relative to the USD hurt performance for Canadian investors with the index ending the quarter up 7.0% in CAD. On a sectorial basis, the market rotation can be observed through the strong performance of Information Technology (+12%), Communication Services (+11%) and Health Care (+8%), which are sectors we consider to be more interest-rate sensitive, and which lagged last quarter. The Energy sector (+11%) also performed well, helped by higher oil
prices, which revisited their 2018 highs. Utilities (0%), Consumer Staples (+4%) and Industrials (+4%) all lagged the index.
International equities finished the quarter up 3.4% in Canadian dollars, lagging its U.S. counterpart once again, which has done a better job vaccinating its population and re-opening its economy. The strength of the loonie relative to currencies like the Japanese Yen and British Pound hurt performance for Canadian investors. On a sectorial basis, the market rotation can be observed through the strong performance of Health Care (+8%), Consumer Staples (+7%) and Information Technology (+7%), which are sectors we consider to be more interest-rate sensitive and who lagged last quarter. Despite improving oil spot prices, the Energy (+2%) sector continues to struggle to attract investors’ attention. Both Utilities (-2%) and Communication Services (-1%) were left out, but some of that can be explained weakness in Softbank Group, which is a large index weight.
We continue to think that equities should be approached from a balanced perspective. Certainly, we have some attractive conditions for risk assets with a recovering economy alongside monetary and fiscal support. However, there are also reasons to be cautious as valuation levels are above historical norms and we have witnessed some areas of exuberance in pockets of the investing universe. There remains value to be found in many sectors. We may have
borrowed a bit from future returns and the stronger returns do tend to happen in the first year of a recovery. As such, we could experience some corrections as the goods recovery slows down but still expect reasonable equity returns from here. On balance, we feel that this is a time to hold a neutral amount of equities relative to your investment policy targets and emphasize getting paid for the risks you are taking within those equity portfolios.
Fixed income markets performance summary
The second quarter of 2021 marked the start of another full year where conditions have been overshadowed by a global pandemic. During the quarter, we emerged from a third wave of rising case counts and related shutdowns as vaccinations took hold. For example, Canada is expected to achieve broad immunity by the Fall of this year. Since the beginning of the pandemic, economic and social conditions have followed the path of the virus. This quarter, however, was more forward looking, focused on how likely a sustainable re-opening really was. While in the first quarter, market optimism was buoyed by a focus on a global re-opening scenario and the benefits to economic growth that would ensue, the second quarter was more of a reflection of the reality of current conditions and the potential to falter on the steps toward the goal of a full economic recovery. Despite this change in market focus, economic data remains on track and central banks have maintained a stable outlook for removing some degree of policy accommodation. Global growth is projected to remain elevated at 6% this year and 5% in 2022 as the economic impact of the losses in 2020 will not be fully recovered until mid 2023. In Canada, GDP growth is expected to rebound to 6% year-over-year (YOY) in 2021 and 4.5% YOY in 2022, while the US economy is projected to recover by 6% YOY this year and 4.3% next year. At this stage in the re-opening phase, the pace of recovery in the services sector will be an important factor in the timing of these
growth projections in the second half of this year.
During the quarter, longer term bond yields declined and the curve flattened as economic data remained strong but failed to meet the lofty market expectations for accelerating inflation and widespread recovery in growth. More recently, the US Federal Reserve has indicated a more rapid timeline in their Statement of Economic Projections (the “dot plot”) and resulting rate hikes, which led to increasing concerns around premature rate hikes at this stage in the recovery. In addition, the US Fed continues to maintain that rising inflation is only temporary and a reflection of bottlenecks and supply chain issues which may slow down the pace of recovery. The recovery of labour markets in Canada and the US have been slightly slower due to the third wave of cases with elevated unemployment rates in Canada and the US at 7.8% (May) and 5.9% (June) respectively. All these factors have contributed to a more moderate outlook where inflation
remains contained. As a result, the yield curve flattened throughout the second quarter and real yields declined further to 0.98% (US ten year). Over the period, two-year Canada bond yields increased 22 basis points to 0.45%, while five year yields declined 1 basis points to 0.98%. Ten-year Canada yields declined 17 basis points to 1.39% while thirty-year yields declined 14 basis points to 1.84%.