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INVESTMENT EXECUTIVE BYB: OUTLOOK 2021 Causes for cautious optimism
Uncertainty abounds, but 2021 promises opportunities in equities markets l BY FIONA COLLIE
January 2021
Despite the generally positive outlook for 2021, embers from the 2020 dumpster fire are still smouldering and pose a risk to equities markets. Burkett, for example, was not enthusiastic about persistently low interest rates, even though low rates typically benefit equities markets.
“We tend to take the view that low interest rates reflect the precarious nature of today’s global economy and [are] not a validation for higher share prices,” he said, adding that “2021 is a market that demands caution.”
One area of concern is how badly the pandemic has burned the global economy, Robertson said: “The big struggle we have is trying to assess whether the damage done to the economy is permanent or structural. At this point, the jury is still out.”
This is the first time the world has dealt with a recession caused by gov- ernment-mandated shutdowns. As such, managers are monitoring whether indica- tors such as the unemployment rate will improve or remain at worrying levels.
Robertson said he’s keeping an eye on unemployment and labour force partici- pation rates “to see if we have to rethink the new world order or the new normal.”
Geopolitical risks, ranging from the potential for civil unrest to continued trade disputes, also are a concern. Earlier this month, Donald Trump supporters stormed the U.S. Capitol building to pro- test the election of President Joe Biden. The Biden administration will likely be more predictable than the Trump admin- istration was, but there are still questions about how the new president will handle trade relations with China, for example.
“We’re not likely to see more tariffs. Will tariffs come off? That remains to be seen,” Bangsund said.
Another trend for equities investors to monitor is the growing divide between the rich and poor. Income inequality, Robertson suggested, will be more per- sistent than other geopolitical risks in the years ahead, and could eventually end up forcing governments to change their tax policies. IE
    positive vaccine news and the
potential for an economic rebound have investment managers bullish on equities markets in 2021, despite renewed lock- downs in many parts of the world.
“The shock and awe of 2020 is now in the rearview mirror and I would expect to see more orderly markets going forward,” said James Robertson, senior portfolio manager, head of asset allocation, Canada and global head of tactical allocation with Manulife Investment Management in Toronto.
Last year was a year of extremes, with equities markets entering a tailspin in March before rebounding later in the year, largely buoyed by the resilient tech- nology and health-care sectors. But will those sectors continue to outperform in the year ahead?
Candice Bangsund, vice-president and portfolio manager, global asset allocation, with Fiera Capital Corp. in Montreal, said value stocks should benefit from a refla- tionary environment driven by accom- modative monetary policy and fiscal stimulus. These measures, she predicted, will spur a rotation away from defensive stocks to more cyclical sectors, such as industrials, financials and materials.
“We expect the laggards of 2020 to become the leaders or assume leader- ship in 2021 due to that reflationary environment,” Bangsund said. “There’s a preference for the cyclical-biased, value-oriented corners of the mar- ket, where we still see some compelling value and more room to run, versus the growth-oriented sectors, such as technol- ogy and health care, where outperform- ance has likely run its course.”
Managers expected Canadian equities to pull ahead of U.S. stocks this year, due in large part to the overstretched valu- ations in the U.S. market and Canada’s
The bond
outlook for 2021
Where the virus goes, so go markets
tape and border checks. The U.K. left the European Union’s single market on Jan. 1. Managers also saw opportunities in emerging market equities — although investors need to be selective. For example, managers were positive about the growth prospects in China but divided when it came to opportunities elsewhere, such as
in Brazil.
Robertson said he sees “nascent signs
of attractiveness” in Brazil because of its diversified economy, which includes agri- culture, oil production and mining, as well as the country’s strong trade relationship with China. “[Brazil is] an economy that is probably underappreciated in terms of how robust it is and, certainly from a valu- ation perspective, it is extremely attract- ive,” Robertson said.
Kevin Burkett, a portfolio manager with Burkett Asset Management Ltd. in Victoria, B.C., said he tends to stay clear of Brazil due to its political risk. Brazil’s government is headed by far-right popu- list president Jair Bolsonaro. Earlier this month, Bolsonaro declared that Brazil was “broke” and suspended the purchase of hundreds of millions of syringes, halting the country’s Covid vaccination campaign.
Burkett looks for high-quality compan- ies that have indirect exposure to emerging markets. For example, he likes Finland- based Kone Corp., which builds and main- tains elevators and escalators and has a significant amount of business in China.
China, which entered and emerged from the coronavirus pandemic first, is set to continue its quick pace of economic growth, Bangsund said, making the coun- try attractive to equities investors. The Chinese economy is expected to grow by more than 8% in 2021, which “is posi- tive for earnings expectations and stock prices,” Bangsund noted.
“We expect the laggards of 2020 to assume leadership in 2021”
 heavy tilt toward cyclical sectors.
In early January, Manulife forecast the Canadian market would post annu- alized returns of about 7.5% over the next five years, and that the U.S. market would return less than 3% over the same period. Also in January, Fiera predicted Canada’s equities markets would see returns of 12% over the next 12 to 18 months, but pre- dicted the U.S. would gain only 0.3% in
the current calendar year.
Europe and the United Kingdom also
were expected to post positive results in their equities markets, although returns could be somewhat muted due to the headwinds of Brexit and the fact that many European economies rely on tourism.
“The restrictions that were put into place in October and November, and again in December, across different parts of Europe have taken their toll on the growth outlook,” Bangsund said. The U.K. entered a third lockdown in January.
Fiera expected international equities to see returns of 1.1% over the coming year.
In the U.K., despite a more trans- missible mutation of Covid-19 that emerged late last year, a vaccine rollout offers hope for the economy. The big head- line risk for the country is Brexit. On Dec. 24, 2020, the U.K. and the European Union reached an agreement that includes a no-tariff and no-quota deal for trade, although there will be additional red
as 2021 opened, bond yield
curves steepened — on Jan. 6, U.S. 10-year Treasury yields hit 1% for first time since March of last year. The economy may feel as if it’s beginning a cyclical recovery, but there are several key differences between a recovey and what’s unfolding now.
Ordinary consumer spending has been deferred while ultra- low interest rates have supported purchases of houses and durable goods. The unemployment rate is high (8.6% as of Dec. 31) and consumer debt has soared.
Will bond prices rise, hold or stumble in 2021?
Avery Shenfeld, chief econo- mist with CIBC, said the outlook is grim. “Government bond yields will be low, but they will climb. Reflecting recovery, the yield curve will steepen.” He added that the Bank of Canada is likely to reduce quantitative easing.
Central banks have signalled that low interest rates will be here for at least a few years. This affects stocks in addition to bonds: low rates mean the present dis- counted value of future company earnings is high, which partly explains why stock prices have risen as the economy stumbled.
A common view is that a com- pany is only worth all the money it will ever make. But future earn- ings are worth a great deal more when interest rates are low: $1 million of earnings in 2031 is worth about $905,000 today using a 1% discount rate. No wonder investors are willing to pay a lot for shares of the companies that generate these earnings.
The low interest rates that are good for stocks are not so good for bonds. If interest rates remain low, bond prices will reflect low cash returns. For conventional bonds, that means low prices.
For investors who would like to hedge the recovery, Canadian Real Return Bonds (RRB) and U.S. Treasury Inflation Protected Securities may be appropriate: if inflation rises, these infla- tion-linked bonds will have handsome returns regardless of what interest rates do.
“If inflation rises faster than nominal yields, then RRBs are a good investment,” said Chris Kresic, head of fixed income and asset allocation with Jarislowsky Fraser Ltd. in Toronto. “[In 2021], we see a continued recovery and upward pressure on interest rates and inflation. So if inflation picks up ahead of interest rates, then RRB returns will beat returns of conventional bonds. If inflation lags rising interest rates, conven- tional bonds will turn out to be the better investment.”
Inflation is therefore the important variable. Before 1970, the value of money was attrib- uted to the quantity of money in circulation. Prices rose in much of the industrialized world at low double-digit rates. But since the financial crisis of 2008, despite central banks creating trillions of dollars in credit, prices have seldom risen more than 2% per year in Canada, the U.S., the U.K., Japan and the EU. Vast pools of cheap labour explain some of that price stability. Low consumer prices have also kept wage-driven inflation low.
Yet the basis for concern is clear: one-fifth of all U.S. dol- lars in circulation were created in 2020 as part of vast stimulus programs. Those dollars could fuel a gush of spending.
Eyes are on the long end of the yield curve, where the U.S. Treasury may allow rates to rise. The word “may” matters, because a new U.S. administration may have to rein in credit, explained Romas Budd, vice-president and senior portfolio manager with 1832 Asset Management LP. “Longer term, yields will move up,” he predicted.
Structurally, that means the 10-year to 30-year spread will steepen and in turn reflect opti- mism for recovery, said Alfred Lee, portfolio manager and investment strategist with BMO Asset Management Inc. A recov- ery priced into the curve may go with rising asset prices, but for bonds, it’s a bear steepener, driv- ing money to shorts in expecta- tion of higher rates.
The consensus: if the recovery continues, even as central banks
hold down the short end of the yield curve, long rates will rise and adept investors will shorten terms and trim back duration to cut risk. This is an interest rate strategy, not a way of harnessing inflation.
“Our outlook for the near term is reflation,” said Konstantin Boehmer, senior vice-president, portfolio manager with the fixed income team at Mackenzie Investments. But Boehmer had a warning for central banks: “The Fed can get away with deficits that no other country can han- dle. Countries with big current account deficits in foreign cur- rencies — Turkey, for example — can’t be reckless with rates. Deficits will drive the prices of their sovereign bonds in major currencies. But the U.S. can begin ending [quantitative eas- ing] and raising rates in the 10-year to 30-year space.”
All things considered, per- haps central banks will ignore price trends to favour recovery. A little bit of inflation, they may reason, won’t be a worry. IE
One-fifth of all U.S. dollars in circulation were created in 2020 as part of vast stimulus programs

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