“Are we at a tipping point in the fight against systemic racism and injustice?
Is long-overdue transformative change, including Canada’s justice system, finally upon us? I believe we are in such a moment, and I am hopeful for our future.”
Jody Wilson-Raybould, MP, Vancouver Granville
On Canada Day, our nation turned 154. After one of the most challenging and dynamic years in our history, we have reason to be optimistic. July 1 also marked the halfway point in a year that has been dominated by COVID-19. There is good news on this front. As of June 30, more than 76% of eligible Canadians (aged 12 and up) had received at least one vaccine dose, making Canada a global leader. Many regions are easing lockdown measures in response to a significant decline in new cases.
We are poised to find our economic footing. The S&P/TSX hit all-time highs in the quarter and most equity markets also posted strong positive returns for Q2. Bonds were largely muted, a change from Q1 when we saw a spike in yields.
At the same time, the tone of this Canada Day was different. Our celebrations were tempered by recognition that Indigenous people are grieving for their lost children. In addition to 751 unmarked graves in Saskatchewan and 215 in B.C. near former residential schools, archaeologists and Indigenous leaders tell us more will be located.
Canada – Historic highs for markets
In May, Canada’s inflation rate rose to 3.6%, its fastest pace in a decade. A trifecta of economic reopening, supply-chain delay and liquidity from stimulus payments caused the leap. This comes on top of a 3.4% increase in April. Consumer demand for durable goods and passenger vehicles is primarily driving the increase. Lockdown measures imposed to tamp down a COVID-19 third wave will likely shrink April GDP numbers. Meanwhile, Canada is becoming a leader in vaccination rates. As businesses resume full operation, we can expect enthusiastic demand in the second half of 2021.
Like most central bankers, Bank of Canada (BoC) Governor Tiff Macklem is trying to find a balance between reining in inflation and tightening too quickly while the economy gets back on its feet. The BoC is continuing to taper its bond-purchase program and signalled it could begin to raise interest rates in 2022. July’s meeting should provide insight into next steps. Even though Q1 GDP was a robust 5.6%, it was lower than projected, and growth in Q2 may also fall short of expectations. Senior decision-makers at the central bank believe the economy will rebound energetically this summer as businesses reopen and vaccination rates advance. Our dollar showed strength based on expectations that Canada would raise rates before the U.S. Then the Fed moved up its timeline for rate increases, and the loonie weakened.
The stock market continued to record all-time-highs. We can expect a strong recovery after lockdown restrictions are lifted. The S&P/TSX Composite rose 2.5% in June, 8.5% in Q2, and 17.3% year to date. Energy and financials were consistent top performers through the first half of 2021. Materials and consumer staples performed well more recently. WTI and WCS advanced to US$73.5 and US$58.6 per barrel, respectively. Gold declined to US$1,756 an ounce. Reversing course from Q1, the 10-year government bond yield slightly declined but stayed above 1.4%.
United States – Rapid expansion continues
Most states have relaxed requirements for social distancing and masks. That allowed the U.S. economy to continue its rapid expansion and return to normal. COVID-19 cases are now at their lowest level in a year, boosting the services and manufacturing sectors that are continuing to display strength. The manufacturing Purchasing Managers’ Index (PMI) rose to 62.6 in June, up from 62.1 in May. The services PMI came in at 64.8 in June, down from a record high of 70.4 in May, but still very healthy. This explosive growth created a surge in demand for goods and services and bottlenecks in the supply chain. Businesses are now willing to pay more for supplies and are passing extra costs along to consumers. The Producer Price Index (PPI), which tracks production costs, rose 6.6% in the 12 months through May, the fastest increase on record. Inflation climbed to 5% in May, the highest reading since August 2008.
For months, the U.S. Federal Reserve maintained that rising inflation would be temporary. It pivoted from this stance in June. Fed Chairman Jerome Powell acknowledged that some inflation pressures are more muscular than expected. At its June meeting, the central bank held interest rates near zero, but is now forecasting at least two interest rate hikes by the end of 2023. Seven of the 18 members of the Federal Open Market Committee – which sets rates – believe the Fed could increase rates as early as 2022. Mr. Powell also said that discussions are underway to determine how to unwind the Fed’s asset purchase program, implemented when the pandemic hit in March 2020.
After President Joe Biden’s original US$2.3 trillion infrastructure plan failed to win Republican support, lawmakers announced in June that they had reached bipartisan support on a smaller revised proposal. The bill is aimed at rebuilding roads, bridges and other large-scale infrastructure projects, a long-time priority for Mr. Biden.
While COVID-19 case numbers continue to wane, vaccination rates have plummeted in recent weeks. In some states (particularly in the South and Midwest) vaccine hesitancy and a missing sense of urgency are to blame. At the beginning of May, approximately 800,000 Americans per day were getting their first shots. Fast forward to June and that number fell below 300,000. The White House acknowledges the rapid decline and plans to press on with vaccination efforts.
U.S. equities continued to perform well. The S&P 500 was up 2.3% for the month of June. The index rose 8.6% in Q2 and 15.3% for the year.
Europe and the U.K. – A good quarter
Unlike their U.S. counterpart, the European Central Bank and the Bank of England (BoE) continued to favour a looser monetary policy, despite better-than-expected economic data across the board. This stance pushed European equity markets higher in June. U.K inflation jumped to 2.1% and will likely temporarily exceed the BoE’s long-term target of 3%.
In June, the Euro Stoxx 50 climbed 0.7%. Similarly, the FTSE 100 rose 0.4% and the DAX went up by 0.7%, despite a dip during the month when the Fed announcement sparked a sell-off. Gains in the travel and leisure, technology and financials sectors contributed to equity returns. On a quarterly basis, European indices climbed in the range of 3.5% to 5%.
Ramped-up vaccinations across Europe contributed to an improved Flash Consumer Confidence Indicator for the region. It showed greater optimism about economic recovery and higher expected consumer spending. Now that almost half the its population is fully vaccinated, the U.K is leading the race to beat the pandemic in Europe (although a late-June surge in the Delta variant of COVID-19 upended the government’s plans to lift restrictions). The prospect of a U.K. open for tourism sent European airline stocks higher. In June, European Commission economic sentiment surveys of major European countries such as Germany and France beat consensus numbers and revealed a positive outlook for business.
China – Seeking ascendance
With great fanfare, China launched its spaceship Shenzhou-12 in June, sending three astronauts into orbit. The team’s mission is to set up a new space station and bring it into service. Echoing its space aspirations, the Middle Kingdom aims to lead the global recovery in the post-COVID era and become an unshakable force for the 21st century. Despite these ambitions, recent U.S. bans on Chinese solar-panel materials, plus ongoing tensions with Australia and Canada, have tested China’s influence on the world stage.
The latest PMI numbers indicate the country is in expansion mode. Despite anaemic growth of 0.6% in Q1, the World Bank predicts that China’s economy will expand by 8.5% this year, leading the global economic recovery.
The Shanghai Composite saw a 0.7% decline for the month and a 4.3% Q2 return.
Japan – Slumping into decline
Sluggish economic data combined with rigorous COVID-19 restrictions weighed on Japanese equity returns. The Jibun Bank Japan Composite PMI that measures business activity across the private sector contracted to 47.8 in June, coming in below the 50 threshold that separates contraction from expansion. While the manufacturing PMI was above 50, it fell short of forecasts due to shrinking output and a shortage of new orders amid COVID-19 restrictions. Not surprisingly, the Bank of Japan left its key short-term interest rate unchanged at -0.1% in June.
The Japanese yen depreciated against the greenback. A rebound in U.S. treasury yields made the U.S. dollar attractive to investors (who have historically used the Japanese yen as a funding currency), further suppressing its valuation.
The Nikkei was essentially flat, declining 0.1% for June and was down 1.2% in Q2.
Our strategy
Inflation has been the hot topic for financial markets for the first half of 2021. Bond yields spiked on inflation concerns in Q1, but reversed course in Q2 and contracted modestly. There is no consensus on how long inflation will persist or how high it might go. In 2020, prices on goods and services declined steeply, which makes the current prices appear relatively higher than they were a year ago. We continue to believe that once we move past these lower base levels, inflation may still be somewhat higher but will not reach concerning levels.
Our moderate overweight allocation to U.S. equities reflects this view since stocks would be the primary beneficiary of this outcome. They will also continue to benefit from accommodative monetary and fiscal policy, which includes a massive US$973 billion infrastructure spending package.
We continue to favour equities overall; however, the recent strength in our equity market and the loonie made us overweight in Canadian equities. During the month, we trimmed our exposure to Canadian equities and invested the proceeds in U.S. equities.
The last word
This July 1st, many of us were thinking about what it means to be Canadian. Sol Mamakwa, Indigenous MPP and residential school survivor, recorded a Canada Day TikTok message. He said, in part:
“Many Canadians are now finally waking up to the horrific price that was paid to establish this country we call Canada. For all of us, this is a good time to reflect on the dark roots of Canada and commit to doing better now and in the future for all our children’s sake.”
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