“Humanity has long since run down the clock on climate change. It’s one minute to midnight on that doomsday clock and we need to act now.”
- U.K. Prime Minister Boris Johnson
The world is now dealing with two major threats to its health and prosperity: the pandemic and global warming. To hammer out solutions, leaders of the globe’s largest economies met face-to-face for the first time since the pandemic began, gathering at the G20 in Italy and the United Nations climate conference in Scotland.
In Rome, getting jabs into arms topped the agenda. Wealthy nations like Canada pledged to donate hundreds of millions of vaccine doses and aid to poorer countries. Focus shifted to climate talks, which continued in Glasgow. The goal of COP26 is to agree on enough concrete measures to cut emissions and cap the average global temperature rise at 1.5 degrees Celsius, aiming for a carbon-neutral world by 2050. A crisis need not become a catastrophe, but time is running out.
Meanwhile, the pandemic death toll topped 5 million globally. In most countries, COVID-19 cases and deaths have shown signs of slowing from spring and summer peaks (except for hotspots in Europe and Russia). With more than 3 billion people fully vaccinated, this downward trend will hopefully persist, allowing economies to edge closer to a pre-pandemic way of life.
A new epoch in monetary policy may be on the horizon. High inflation, positive job numbers and economic growth are motivating central banks to start winding down their massive stimulus spending. Next will come accelerated timelines for raising interest rates from their current ultra-low levels. The Bank of Canada (BoC) has been aggressive, causing Canadian bond yields to spike in October. The U.S. Federal Reserve (the Fed) will start tapering bond purchases this month.
After a striking decline in September, equity markets resumed their ascent. Earnings remain robust and positivity persists, based on pent up demand and an enormous savings glut that is burning a hole in consumers’ pockets.
Canada – First major nation to halt QE
In late October, the BoC said it will hold its benchmark interest rate at 0.25%, where it has rested since the pandemic began, but signalled rate hikes for Q2 of 2022. BoC Governor Tiff Macklem added that high energy prices and supply bottlenecks will push inflation still higher before it drops back to around 2% next year. The central bank ended its bond-buying program, which it introduced to keep lending cheap in order to bolster the economy. The BoC acted based on strong job growth, high vaccination rates, robust economic growth, and concerns about persistent inflation.
In August, GDP grew 0.4%. September’s preliminary reading is basically flat, putting Canada’s economy 1% below its pre-pandemic peak. Sectors hit hardest – accommodation, food services, and air travel – are recovering. However, manufacturing and retail sales are underperforming thanks to a shortage of materials and products. The BoC recently revised its Q3 growth forecast downward from 7.3% to 5.5%. In an encouraging sign, 157,000 new jobs were added in September, which puts employment numbers above pre-coronavirus levels.
Oil prices held the spotlight; they reached their highest level since October 2014, with West Texas Intermediate (WTI) hitting US$85.4 per barrel. Although overall demand remains well below pre-pandemic levels, oil prices rose 20%. Contributing to the increase were tight supply, depleting stockpiles and fuel switching caused by coal and gas shortages. Weather and the likelihood that oil producers such as OPEC+ won’t increase production are adding uncertainty.
The stock market climbed to all-time highs. The S&P/TSX Composite returned 5.1%, capitalizing on early-month optimism after September’s 2.2% decline and a muscular energy-sector performance. While the U.S. greenback weakened, gold recovered to US$1,790 per ounce. After the BoC’s stronger-than-expected announcement plus concerns over higher inflation, yield on 10-year government bonds rose to 1.69%.
United States – Tapering will begin
In Q3 of 2021, growth in the world’s largest economy slowed to a 2% annualized rate, its most stunted pace since mid-2020. A spreading Delta variant dampened consumer spending on leisure and travel. Supply-chain bottlenecks also made goods – particularly automobiles – hard to find. Consumer spending, which accounts for approximately 69% of the U.S. economy, increased just 1.6% in Q3, after rising 12% in Q2.
Toward the end of Q3, the Delta variant pushed up jobless claims, but an October case decline brought weekly jobless claims to a fresh, pandemic-era low. The U.S. has lost over 750,000 people to COVID-19, more than any other country. Average new daily infections currently hover around 72,000, a 58% decline since a fourth-wave peak of 172,500 on September 13. Infection numbers have fallen in all U.S. regions, most notability in the South, which was hit hardest by the Delta outbreak. Immunization rates have slowly picked up; about 58% of all Americans are fully vaccinated.
At the G20 leaders’ summit in Rome, President Joe Biden criticized Russia and China for failing to support G20 initiatives to fight climate change. He pointed to their lack of concrete actions needed to achieve targets set out in the Paris climate accord. He warned world leaders that more needs to be done and called on them to rise to the challenge in Scotland at the COP26 climate conference, running until November 12.
U.S. inflation has climbed to its highest rate in nearly three decades. On November 3, the Fed announced that it will now begin tapering its US$120 billion monthly bond purchases. Once quantitative easing ends, central banks typically raise interest rates to combat inflation.
Propelled by strong fundamentals, U.S. equity markets continued their surge to all-time highs. The S&P 500 rose 7.01% in October.
Europe – Cases headed in the wrong direction
Eurozone headline inflation for October exceeded expectations, coming in at 4.1% thanks to high energy prices, rising demand and an ongoing supply squeeze. European Central Bank (ECB) policymakers expect inflation to exceed 2% next year, but can’t agree whether it will remain above target in 2023. The ECB pushed back against market bets that interest rates will increase next year.
During Q3, seasonally adjusted GDP for the eurozone and EU grew by 2.2% and 2.1%, respectively. Meanwhile, Germany struggled when chip shortages stalled car manufacturing. Europe’s largest economy cut its growth forecasts for 2021 to 2.6%. However, it expects a boom next year and raised estimates to 4.1% before growth normalizes at 1.6% in 2023. German consumer confidence has improved according to the GfK Consumer Climate Index; it rose from 0.4 points in October to 0.9 points for November. More price hikes seem likely, so citizens are shifting from saving to buying.
Europe is the only major region where COVID-19 numbers are going in the wrong direction. In October’s final week, cases and deaths climbed 18% and 14%, respectively. Low vaccination rates in Eastern Europe contributed to this upward trend; full vaccination rates in Romania and Ukraine are just 30.7% and 16.5%, respectively. People are shunning readily available inoculations because they distrust authorities.
In October, the Euro Stoxx 50, FTSE 100 and DAX advanced 5.9%, 3.4% and 4.2%, respectively.
Japan – Sluggish growth
The ruling Liberal Democratic Party (LDP) under new Prime Minister Fumio Kishida won a parliamentary majority in October’s general election.
In Q3, Japan’s economy grew at an 0.8% annualized rate. Japan’s central bank committed to keeping an easy monetary policy even if other nations pull back on stimulus spending. The target for short-term interest rates remains at -0.1% and around 0% for 10-year bond yields. Inflation is projected to stay well below 2% for at least two more years. Although rising commodity prices pushed wholesale inflation to a 13-year high in September, sluggish domestic demand held consumer inflation near zero. Retail sales fell 3.2% and 0.6% in August and September, respectively.
October saw the Nikkei return 4.2%, recovering from a decline near the month’s start.
China – GDP disappointment
On October 29, Evergrande, China’s highly indebted property developer, faced a final deadline for a US$47.5 million coupon payment that was due a month earlier. It made its payment and avoided defaulting on more than US$19 billion worth of international bonds. That was a little less than a week after it made another last-minute coupon payment of US$83.5 million. Evergrande’s struggles became a focal point when Beijing increased restrictions on excessive debt levels in the property sector, which makes up about 25% of Chinese GDP when including related industries. China’s property sector has total outstanding debt of US$5 trillion, which is roughly equal to the GDP of Japan, the world’s third largest economy. Increased restrictions are affecting other Chinese developers. Kaisa Group and Yango Group received credit downgrades and suffered share-price declines because of poor access to funding.
China’s third-quarter GDP grew a discouraging 4.9% compared to a year ago, down from expectations of a 5.2% expansion. Industrial production rose just 3.1% in September, lower than the anticipated 4.5%. Elevated coal prices and an electricity shortage prompted authorities to impose blackouts, forcing many factories to halt production. Beijing has since emphasized that it will ensure coal and electricity are available in the future. Growth was also hampered by tighter regulations on sectors such as technology and real estate.
The Hang Seng rose 4.65% in October. For the Shanghai Composite, poorer-than-expected growth numbers triggered a late-October plunge of 1.3%.
Our strategy
After taking a month off, equity markets are again soaring to all-time highs. The S&P 500 is up 110% since March 2020 lows. While we don’t expect future returns to match the exuberance of the last 18 months, there is forward momentum and return potential for stocks, even though significant risks persist.
Conversely, we expect tightening monetary policy will challenge bonds. In addition to central banks tapering the bond supply, interest rates are poised to move up in early-to-mid 2022. While our positioning in bonds that are less sensitive to interest rates should reduce much of the impact, near-term returns in this asset class are unlikely to be positive.
To be clear, we firmly believe bonds are an essential part of a balanced and diversified portfolio, but we currently believe stocks offer a better value proposition. In addition to our explicit overweight allocation to U.S. equities, we have allowed our Canadian and international equity weights to drift up, but still within range, as equities outperformed bonds.
The last word
We will only know in hindsight if we’ve reached a turning point in the pandemic, inflation and climate change.
On November 4, the International Energy Agency said that global warming could be limited to a rise of 1.8 degrees Celsius above pre-industrial levels by 2100 if all COP26 commitments are fulfilled on time. Welcome news because the UN reported in September that the planet is hurtling toward a rise of 2.7 degrees.
The Oxford Dictionary just made “vax” its word of the year, a tribute to the 3.9 billion people who are at least partially vaccinated and a nod to science for releasing us from the health and economic stranglehold of COVID-19.
Central banks are turning off the tap of extraordinary stimulus measures, trying to find a balance between supporting optimism and managing inflation.
Nothing’s for sure, but there are hopeful signs.
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