“It’s a marathon, not a sprint.”
- Phillip C. McGraw
“After a blazing start to the global recovery, it is becoming increasingly apparent that the last mile will be the toughest due to supply challenges and the spread of the Delta variant.”
- Douglas Porter, Chief Economist, BMO Financial Group
On July 23, 2021, the cauldron flame of the 2020 Summer Olympics was finally lit in Tokyo. Much like the pandemic, the Games were shrouded in uncertainty. After a year’s delay, would they still go ahead while Japan was in a state of emergency? Would spectators be allowed? Would they be a super-spreader event?
The Games were a microcosm of our global environment. COVID-19 infections forced athletes to drop out. A few were barred for violating COVID-19 protocols. And, like many of us, some elite athletes publicly struggled with mental health. The comparisons don’t stop there:
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Competition – the world’s two largest economies and political rivals, the U.S. and China, also had the two highest medal tallies.
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Co-operation – any team trying to succeed must make sacrifices just as Democrats and Republicans compromised to pass a bipartisan infrastructure bill.
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Sportsmanship – the Italian and Qatari high jumpers opted to share a gold medal in the same spirit as countries and scientists came together to develop, produce and ship billions of vaccine doses.
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Winners and losers – bonds and U.S. equities performed well this month, while Chinese and Japanese equities faired poorly.
Despite worries, the Summer Games played out successfully. They delivered a nostalgic sense of wonder, national pride and international community that we feel together just once every four years (or five, this time around). They even provided some comic relief as Canada’s life-sized moose mascot and Australia’s kangaroo and emu mascots were briefly and mysteriously kidnapped.
Canada – Economic optimism plus athletic euphoria
Inflation remains in the spotlight. In June, inflation fell to 3.1% from May’s 3.6%, supporting Bank of Canada (BoC) Governor Tiff Macklem’s view that rapid price increases will likely slow. The BoC is firmly committed to keeping inflation under control. In July, the central bank scaled back its weekly rate of bond purchases and left the benchmark interest rate at 0.25%, where it will likely stay for at least the second half of 2021.
Pandemic lockdowns weighed on business activity. Canada’s GDP contracted 0.3% in May after a 0.5% decline in April. Right now, it sits about 2% below the pre-pandemic level of February 2020. Early numbers indicate that June GDP growth will be just shy of 1%, with retail sales and food services performing well as the broader economy reopens.
The S&P/TSX Composite was up 0.8% in July and posted an impressive 18.2% gain so far this year. Energy declined sharply during the month, but consumer stocks made up a chunk of the difference. WTI and WCS were flat at US$73.1 and US$58.7 per barrel, respectively. Gold advanced to US$1,814 an ounce. Since hitting a high of 1.68% back in March, the Canadian 10-year government bond yield has steadily retreated and now sits at 1.20%, down from 1.40% last month. Investors have grown conservative amid concerns about the Delta variant and global supply-chain bottlenecks at the same time as the BoC is reducing stimulus measures.
Prime Minister Justin Trudeau is signalling that he will trigger a snap election just two years after the last one. He seems ready to place a big bet that Canadians will help his Liberals regain a parliamentary majority thanks to a rebounding economy and Canada’s come-from-behind performance to capture a podium position in the global vaccination race.
U.S. – Powerhouse economy matches medal might
The world’s largest economy continued its rapid expansion. GDP grew 6.5% in Q2, pushing the economy’s size past its pre-pandemic level. Growth was spurred by unprecedented levels of fiscal stimulus that fuelled consumer spending, which increased by 11.8% in June as economies reopened from prolonged lockdowns. Celebrations were toned down, however, because GDP had been forecast to rise by 8.5%. Supply-chain shortages were the stumbling block as businesses wrestled with higher prices and stepped-up demand.
Payrolls expanded by an average of 600,000 a month during Q2 of 2021. While the labour market and economy continue to display strength, challenges loom on the horizon. The fast-spreading COVID-19 Delta variant poses the greatest risk to the nascent rebound, especially after vaccination rates plateaued in July. Although consumer and business confidence continued to climb throughout Q2, the highly contagious Delta variant has put that trend in jeopardy. The U.S. Centers for Disease Control and Prevention recommended that vaccinated people mask up again in areas with high infection rates – a description that covers roughly two-thirds of all U.S. counties. This announcement highlights a stark reversal in the trend line and came as the seven-day average for new cases rose sharply. The U.S. now leads the world in daily average new cases.
Following months of negotiations, the Senate reached bipartisan support for President Joe Biden’s US$1 trillion infrastructure bill. Included in the agreement is funding for roads, bridges, rail, broadband and other physical infrastructure.
The U.S. Federal Reserve also left interest rates unchanged, saying asset purchases would continue at US$120 billion per month. Fed Chair Jerome Powell indicated that the central bank would not hesitate to pivot its stance on monetary policy if inflationary risks emerge. Mr. Powell has maintained that the Fed is willing to let inflation run above its 2% target in order to allow the labour market to recover to pre-pandemic levels. He reiterated his view that inflation will settle back down.
U.S. equities continued their climb as the S&P 500 gained 2.4% in July and posted an 18.0% return for the first seven months of 2021. Corporate earnings remained strong; Q2 results are expected to show an 87.2% increase from a year ago, according to financial markets data provider Refinitiv.
Europe and the U.K. – Recession-free and away to the races
The European Central Bank (ECB) hiked its inflation target to 2% over the medium term. It left interest rates unchanged, saying rates will remain where they are, or go lower until inflation reaches 2%. The ECB also vowed to maintain “a persistently accommodative monetary policy stance” in order to meet that target. Inflation has picked up over recent months, largely due to the lower base from 2020, higher energy prices, and temporary factors that we don’t expect to continue. It is likely to rise even more in the second half of 2021, before declining as these transitory factors fade away.
The 19-member eurozone economy grew faster than expected in Q2 as coronavirus restrictions were lifted and vaccination campaigns made significant progress. In the second quarter, the economy registered a massive 8.3% annualized GDP growth. Economic activity is expected to accelerate in the next six months as consumers enjoy more liberties. An uptick in consumer spending, strong global demand and accommodative fiscal and monetary policies will lend crucial support to the recovery and stimulate a continued decline in unemployment.
Yet, uncertainties remain. The near-term outlook hinges on a contained pandemic and the economy’s response after reopening. According to the ECB’s June macroeconomic projections, the eurozone will achieve annual real GDP growth of 4.6% in 2021, 4.7% in 2022 and 2.1% in 2023.
In July, EU equities (Euro Stoxx 50) climbed 0.7% and U.K. equities (FTSE 100) rose 0.1%.
Japan – Troubled games, troubled economy
While Japan was a leading medalist at the Olympics it hosted, its economy remains mired in a lockdown-driven slump. The real GDP growth rate for Q2 2021 was ‑3.9% on an annualized basis, registering negative growth for the first time in three quarters. Japan's GDP also dipped by 0.04% for May, a second straight monthly decline, which was driven by a reduction in consumption and manufacturing. Exports and imports fell by 0.2% and 2.6%, respectively, despite the economic recovery of overseas trade partners. The Nikkei declined by 5.2%.
The 2020 Tokyo Olympic Games are expected to cost US$15.4 billion to host. Much of that money won’t be recouped since spectators were banned from attending events.
China – Ahead on the podium, markets mired
China was a leader in the Olympic gold-medal count. The Middle Kingdom has also been at the forefront of equity market volatility, driven by policy decisions that seem to be signalling Beijing’s desire for tighter control.
Early in July, China’s cyber watchdog unveiled new rules to police overseas stock listings of Chinese companies. It told the behemoth ride-hailing app DiDi to stop registering new users and removed it from Chinese app stores just a few days after the stock’s splashy IPO on the New York Stock Exchange, citing concerns about cybersecurity and collection of personal data. Two other Chinese companies, Full Truck Alliance (NYSE) and Kanzhun Ltd. (NASDAQ), face similar challenges.
Beijing also announced crackdowns on the country’s for-profit education industry. It plans an overhaul of its educational tech sector aimed at private tutoring and test-prepping giants. Squarely in President Xi Jinping’s crosshairs is widening social inequality that allows China’s wealthy and privileged to maximize their children’s educational advantages. As a way to level the playing field, he aims to bar companies that teach the school curriculum from making profits, raising capital or going public.
On the economic policy front, China seems to be headed in the opposite direction from most major economies and has taken steps to encourage banks to increase lending. Beijing has provided much smaller fiscal and monetary support to the economy during the pandemic than Western countries and thus has a lot more room to bolster domestic economic growth.
The Shanghai Composite declined 5.4% in July.
Our strategy
Bond yields pulled back significantly, off 50 basis points (bps) from their highs this year and 20 bps in the last month alone, leading us to believe we are well positioned. Bonds are offering little returns, especially when inflation is factored in, and currently have a greater sensitivity to movements in interest rates. Our bond holdings have lower sensitivity to changes in interest rates thanks to our allocation decisions and our fund managers’ investment choices.
Bonds remain essential to portfolio construction, providing diversification and reduced volatility in times of stress. Nevertheless, we believe equities should continue to benefit from accommodative fiscal and monetary policies and momentum from economies opening up all over the world. Accordingly, we have maintained an overweight position in stocks, specifically in the U.S. where the market has continued to perform well due to the diversity and quality of companies located there, plus supportive policies.
The last word
We build robust and diversified portfolios that should fair relatively well in most environments. Like Olympic athletes, we can’t manage events and outcomes around us, but we can perfect our approach, prepare and manoeuvre into good positions by understanding the big picture, then adjusting to it.
The Delta variant and a sharp increase in vaccinations hang over all investment and political decisions. But positive boosts (like we got from our multi-medal female swimmers and women’s gold-medal soccer team, gold in the men’s 200-metre race – for the first time since 1928 – and men’s decathlon, plus other soaring Olympic performances) keep us hopeful about a continued strong recovery during the second half of 2021.
Information contained in this publication is based on sources such as issuer reports, statistical services and industry communications, which we believe are reliable but are not represented as accurate or complete. Opinions expressed in this publication are current opinions only and are subject to change. BMO Private Wealth accepts no liability whatsoever for any loss arising from any use of this commentary or its contents. The information, opinions, estimates, projections and other materials contained herein are not to be construed as an offer to sell, a solicitation for or an offer to buy, any products or services referenced herein (including, without limitation, any commodities, securities or other financial instruments), nor shall such information, opinions, estimates, projections and other materials be considered as investment advice, tax advice, a recommendation to enter into any transaction or an assurance or guarantee as to the expected results of any transaction.
You should not act or rely on the information contained in this publication without seeking the advice of an appropriate professional advisor.
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