“Change before you have to.”
- Jack Welch
August could turn out to be the linchpin month that shapes the rest of 2021. A linchpin holds a wheel onto its axle. The events set in motion during August may or may not keep the wheels from coming off global progress.
Less than a week after the U.S. and its coalition partners fully withdrew from Afghanistan, the local government collapsed and a chaotic scramble to evacuate tens of thousands began. Two decades of conflict, countless lives lost and trillions of dollars spent did not deliver lasting freedom or peace. What happened there will influence how the world responds to future geopolitical conflicts.
Canada’s 44th federal election campaign is nearing the finish line. Election polls show the incumbent Liberals and rival Conservatives locked in a close race, with the New Democratic Party looking to make gains.
On the economic front, the U.S. Federal Reserve announced its much-anticipated intention to taper bond purchases later this year. However, August’s unexpected weak jobs growth may postpone that move.
China is continuing regulatory reform within its technology sector and is stepping up controls so that more citizens are included in the Middle Kingdom’s rising prosperity. These rapid developments are creating ambiguity for investors.
COVID-19 remains the world’s largest unknown, with all eyes on the Delta variant and emerging mutations. Reported cases and hospitalizations spiked, especially in the U.S. where vaccination rates remain low and have plateaued. Globally, governments are introducing defensive measures such as vaccine passports and travel bans. Uncertainty about COVID-19 variants is throwing cold water on any optimism that blossomed with this summer’s reopenings. An invigorated coronavirus is impacting business and slowing down hiring. Booster shots for wealthy nations while the majority of the world’s population remains completely unvaccinated are raising uncomfortable questions.
Ignoring all these uncertainties, global equities continued their ascent in August. Most major markets were up sharply; some even reached new highs. Bond performance remained muted and flat.
Canada – Rolling the dice
Canada’s economy shrunk in Q2, catching economists by surprise. It contracted by an annualized 1.1% between April and June, in contrast to Statistics Canada’s forecast of 2.5% growth. Slowdowns in home resales and exports contributed substantially to this decline. Business and government spending grew while other areas held steady. A cooling real estate market is a welcome reprieve after the sector’s frenzied overheating. Historically low interest rates were very attractive to buyers.
Statistics Canada estimates the economy contracted 0.4% in July, with manufacturing, construction and retail mostly to blame. This puts the level of economic activity in July about 2% below pre-pandemic levels in February 2020. Inflation jumped to 3.7%, which forced the Bank of Canada to find a balance between supporting the economy and keeping inflation in check.
Seeking a Liberal majority government and a third mandate, Prime Minister Justin Trudeau called a snap election (just two years after the last election) as Canada entered a COVID-19 fourth wave. He hopes voters will reward his stewardship of the pandemic response and Canada’s status as a global leader in vaccinations. His gamble could backfire, however. Polling numbers have tightened significantly mid-campaign.
Canada’s S&P/TSX rose 1.63% in August, the seventh straight month of gains. Information technology led the way as Shopify shares set another all-time high and registered a year-to-date gain of about 20%. WTI and WCS traded lower at US$68 and US$56 per barrel, respectively, on concerns that rising COVID-19 case counts will hurt demand. Gold climbed above US$1,800 after a dip at the beginning of August. Canadian 10-year government bond yields were flat, declining modestly from 1.20% to 1.18% last month.
U.S. – Losing its footing
It appears that U.S. growth has begun to slow. This comes after a rollercoaster recovery that saw the world’s largest economy return to pre-outbreak levels faster than any other G7 nation. Meanwhile, leading indicators are starting to show weakness as infections spread across most states, especially among unvaccinated people. A University of Michigan’s consumer sentiment estimate plummetted from 81.2 in July to 70.3 in August. Confidence levels are below the early pandemic reading of 71.8 in April of 2020. The U.S. is reporting a daily average of 100,000 COVID-19 hospitalizations for the first time since the contagion’s peak last winter, an increase of roughly 500% in the last two months.
Surging infections are a renewed threat to the service and tourism sectors. While broad-based lockdowns appear unlikely at this time, a lot of major, in-person events have been postponed or cancelled and fast food restaurants such as McDonald’s and Taco Bell have closed indoor seating areas in many locations. A National Restaurant Association survey found three in five respondents chose takeout as their preferred dining option. Additionally, the European Union dealt a blow to airlines when it formally recommended travel bans on American tourists hoping to visit its 27 member nations.
During the 2020 presidential campaign, Joe Biden promised to get American troops out of Afghanistan. As U.S. combat forces began leaving in May, the Taliban reclaimed territory. Kabul fell in August, stranding tens of thousands trying to escape via a harrowing airlift from Hamid Karzai International Airport. The chaotic withdrawal was the biggest foreign policy disaster of Mr. Biden’s presidency, pushing his approval ratings down to a record low 48%. Foreign allies, Republicans and some Democrats were sharply and openly critical. This miscalculation and Afghanistan’s collapse added to international geopolitical tensions.
Even the destructive forces of the Delta variant and Hurricane Ida did not shake equities, which remained resilient. Strong corporate earnings helped the S&P 500 finish August up 2.9%, notching a seventh straight winning month. U.S. Federal Reserve Chair Jerome Powell gave equities extra support during his remarks at the annual economic policy symposium in Jackson Hole, Wyoming. He said that the central bank will likely begin tapering bond purchases before 2021 is over, but added that there is “much ground to cover” before the Fed would consider rate hikes. Although inflation continues to hover above the Fed’s 2% target, investors were happy to hear that interest rates will stay near zero until the economy approaches maximum employment.
Europe – Recovery can carry on
After getting off to a slow start, Europe’s vaccine rollout has gained momentum. An improved vaccination picture plus continued positive numbers among purchasing managers’ indices point to sunnier prospects for business growth. Economic reopening is still at an early stage and recovery could potentially make up for lost time in coming months.
On the downside, eurozone inflation exceeded most economists’ expectations and climbed to a decade high of 3%, up from 2.2% in July. Supply-chain disruptions have significantly contributed to rising prices for consumers. Analysts and the European Central Bank (ECB) believe the situation is temporary. Although the ECB is unlikely to hike rates, inflation could prompt a slowdown in its €1.85 trillion pandemic emergency stimulus program.
The momentous German election is less than a month away. Polls are showing a wide range of outcomes, with Chancellor Angela Merkel’s conservative CDU/CSU bloc maintaining the lead. While austerity was once the region’s watchword, it is not high on any candidate’s agenda. This could translate into fiscal support for the economy. A more left-leaning coalition could usher in tighter regulations around labour, service and housing markets, which would potentially slow Germany’s growth.
Stock markets were upbeat. The STOXX 50, FTSE 100 and DAX indices rose 2.6%, 2.1% and 1.9%, respectively.
China – Transformative trends
Up to now, China’s economic recovery has led the global pack, rebounding to pre-pandemic levels. However, this expansion appears to be slowing. July’s factory output and retail sales grew 6.4% and 8.5%, respectively, on a year-over-year basis – healthy numbers but well below forecasts of 7.8% and 11.5%. Businesses grappled with higher costs and supply bottlenecks, renewed COVID-19 restrictions that disrupted factory production, and fallout from flooding in central China. The early Purchasing Managers’ Index came in at 49.2 for August, the worst reading since April 2000. This decline from July’s 50.3 (50 is the boom/bust benchmark) signals a slowdown.
President Xi Jinping has set a goal for China to achieve “common prosperity.” The purpose is to ease inequality and narrow the yawning wealth gap between its richest and poorest citizens. Beijing is targeting inequality with tightly controlled changes. The brutal 996 work culture is now illegal (named for a practice where people work from 9 a.m. to 9 p.m. six days a week). This comes after a crackdown on monopoly businesses in the tech sector, which were major beneficiaries of 996 hours. It follows a proposed ban on companies with large amounts of consumer data from listing on U.S. stock exchanges. On August 31, China introduced new rules that forbid those under 18 from playing video games for more than three hours a week. These changes will have an outsized impact on the media and tech sector, where many of China’s largest companies – like online gaming giant Tencent – operate.
The Shanghai Composite rose 4.3% in August, despite a slowing growth pace. Hong Kong’s Hang Seng fell by -0.3% in August, weighed down by Chinese technology behemoths such as Tencent, Meituan and Alibaba, which are not currently listed on the Shanghai exchange.
Japan – Riding the COVID seesaw
Japan’s economy grew at an annualized rate of 1.3% from April to June, a much stronger turnaround than economists expected after a 3.9% decline in Q1. Corporate spending was a bright spot. Consumer spending remained sluggish due mainly to seesawing COVID-19 restrictions. Japan’s GDP is now about 1.5% below its pre-pandemic level.
In mid-August, Prime Minister Yoshihide Suga extended the state of emergency and expanded it to seven additional prefectures in an effort to quell spiking case numbers that overburdened hospitals. Q3 growth estimates for the world’s third-largest economy have been downgraded from 5.2% to 1.4%. Recovery is not likely until Q4.
After a steep decline in July, the Nikkei 225 posted a 3% gain in August.
Our overweight allocation to a red-hot U.S. equity market with an offsetting underweight allocation to the flat bond market significantly contributed to returns. Strong corporate earnings, favourable economic policies and longer-term optimism helped boost stocks. Factors including supply-chain bottlenecks and COVID-19 waves led BMO Economics to cut its Canadian GDP forecast for both Q3 (to 5.0% from 6.0%) and Q4 (to 4.0% from 5.0%).
Continued outperformance in expensive large companies – like Shopify – has increased concentration in a few names at the top of North American indices.
We remain comfortable with our tactical positioning, but continued outperformance in equity markets is pushing some of our portfolios toward the upper end of our allocation range.
The last word
Exacerbated by climate change, events like massive wildfires, hurricanes, flooding and drought are becoming commonplace. Beyond extreme weather we have geopolitical turmoil, economic expansion and contraction, the pandemic and how to manage it, plus harsh divisions between left-wing and right-wing voters.
The final quarter of 2021 will largely be uncharted territory, with many variables and moving parts. However, up to this point equity markets apparently decided to choose optimism. They are looking for opportunities, which will help keep the wheels securely attached to a global recovery.
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