2021 Connor, Clark & Lunn Financial Group
←
→
Page content transcription
If your browser does not render page correctly, please read the page content below
FORECAST
WHAT’S INSIDE
2021
This year’s Forecast looks at the cyclical factors influencing
THE CYCLICAL ENVIRONMENT 1
the shorter-term economic outlook. In addition to
RISKS TO OUR OUTLOOK 4 considering the evolution of secular forces for the years
ahead, we examine market valuations and technical
THE SECULAR ENVIRONMENT 6
conditions. Taking into account all these factors, we set
FINANCIAL MARKETS 7
the framework for our portfolio strategy. Throughout
2021, updates to our Forecast will be highlighted in our
PORTFOLIO STRATEGY AND STRUCTURE 10 monthly newsletter – Outlook.
SUMMARY 13INTRODUCTION
Following the massive shock of the COVID-19 pandemic and ensuing economic shutdowns, a new cycle is emerging. The economic
cost has been significant, US$10.3 trillion by one estimate1 , which dwarfs the GDP of every country in the world except two. According
to the International Monetary Fund (IMF), countries worldwide have put nearly $12 trillion of fiscal action in place and an additional
$7.5 trillion in monetary policies, in an enormous effort to prevent the health and economic crises from becoming a financial crisis. This
has been a large negative jolt for society as a whole and the global economy. However, economically, the worst appears to be behind
us, and with the welcome news of effective vaccines, we can begin to look ahead.
Over the next few pages, we will assess the acceleration of a number of the shifts that have been underway globally. We believe that
the shift in primary policy goals from monetary to fiscal, as well as the joint policies that will result in financial repression are the most
significant for investors. These supplement our main secular outcome from last year – that inflation pressures could finally take root in
this coming cycle. Notably, through this, the performance of financial markets has disconnected from economic cycles for three years
running now. We turn to outline our thinking on market valuations and technical conditions in light of this past year’s performance and
finally, we outline our portfolio strategy.
THE CYCLICAL ENVIRONMENT
For the first time in more than a decade, we are in a new business cycle. However, what transpired in 2020 was not a typical textbook
recession, so the normal characteristics of a post-recession era are not present today. Our cyclical outlook must in turn account for the
odd qualities of the start of the cycle. Nonetheless, with policy firmly in the driver’s seat, as long as the vaccines are effective, we can
look forward to a period of global synchronized growth.
CHART 1: WORLD ECONOMY TO STABILIZE
World: A Calmer and Clearer Path Ahead
110
• The global growth trajectory has not looked this clear in decades. Coming Activity to return to
pre-pandemic levels this year
out of the Great Financial Crisis (GFC), there was considerable uncertainty 105
in a significant number of areas: the state of the housing market; the
depth of unemployment; the ability for low rates to stimulate demand; 100
the path for United States (US) household balance sheet repair; and the
Index
unintended effects of then-innovative policies like quantitative easing and 95
negative interest rates. Coming out of the recent pandemic-driven shock,
2020 Projection
90
there was uncharacteristic strength in housing demand and prices, savings Current Path
rates, and retail sales of goods. Inventory levels fell and a tidal wave of 2019 Projection
85
bankruptcies were staved off by government support measures; pent up Oct-2019 Apr-2020 Oct-2020 Apr-2021 Oct-2021 Apr-2022 Oct-2022
demand is high. Moreover, structural differentiators this cycle bode well
Source: Organisation for Economic Co-operation & Development, World
– the services sector, unusually, has been hardest hit. Notably, this sector Bank, Macrobond, Connor Clark & Lunn Investment Management
Note: Indexed 2019 Q4 = 100
can recover faster, with no large scale factory shutdowns. Additionally,
there is a large, lower-wage labour supply to tap when needed to re-staff
hotels, cruise lines, restaurants, and other personal services. This makes the economic outlook solidly positive.
• All components of policy are expected to remain universally supportive for growth. Trade policy is expected to improve with the new
US Administration easing relative to the past couple of years’ divisive tariffs and countervailing duties, leaving a calmer environment
to expand segments of international trade. Monetary and fiscal policy will not only stay accommodative, but are likely to push
demand actively higher as governments direct spending to large projects, such as renewing infrastructure. Global efforts pushed
monetary and fiscal policy support to over 12% of world GDP. In aggregate, our base case forecast for global growth is positive, likely
the most optimistic it has been in over seven years.
1
What is the cost economic cost of COVID-19?, (2021, January 9). The Economist FORECAST 2021 | Page 1Canada: Fiscal Policy and Immigration Policy Remain Tailwinds CHART 2: CANADA’S 2020 DEFICIT PROJECTION
• Shutdowns in the largest provinces this winter will give way to a strong RANKS HIGH AMONG ITS PEERS
rebound in the second half of the year, but without any inflation concerns Deficit as % of GDP
-20 -18 -16 -14 -12 -10 -8 -6 -4 -2 0
given the large output gap that re-opened due to the pandemic. In
Canada
addition to the factors described above, Canada in recent years has United States
differed from other countries because of significant resilience in the labour United Kingdom
Japan
market, helped in turn by positive net immigration. The influx of highly
Italy
skilled immigrants did not deter the unemployment rate from trending to Belgium
decade lows. As the borders reopen this year, we anticipate immigration France
Australia
will resume supporting domestic growth.
Netherlands
• Government backing for those most impacted by the virus, combined Germany
Sweden
with new program spending, will result in material deficits but at the
Switzerland
same time will contribute meaningfully to growth. So far this fiscal year,
tax and spending measures pushed the federal deficit to 17.5% of GDP Source: IMF, Macrobond
(C$382bn). The budget deficit is expected to remain in excess of 5% of
GDP for the next two years, in conjunction with a stimulus package to “jumpstart” the economy. This is a material change – Canada
has run a fiscal budget within 1 percentage point of GDP since 2013. As a result, Canada’s net debt will surge from 31.2% of GDP up
to 52.6% in fiscal year 2021/22. There are two implications from this; government spending will be a net contributor to aggregate
demand because of generous programs, but at a potential cost in our ability to finance our debt. Canada has run afoul of fiscal
imprudence before, as recently as the mid-1990s, causing ratings agencies and foreign investors to respond unfavourably. So far,
the common worldwide response to the pandemic has given governments a free pass to massive debt accumulation. However,
Canada’s net debt accumulation during this crisis was the greatest amongst the advanced economies. Because we began the crisis in
better shape than most, our projected debt is only slightly worse than, but broadly in line with, our AAA-rated peers. So far so good.
• The Canadian consumer has become more interest sensitive; even as the total debt levels have risen this past year, interest servicing
costs have eased more than 2.3 percentage points from a year ago to just 13.2% of disposable income. While the potential for further
debt-fueled spending from here is limited, a rebound in services spending helped by pent-up demand should help recreation, tourism
and other services post strong rebounds. Moreover, Canada’s resource sectors will benefit from a strong cyclical recovery. Taken
together, Canada’s GDP will likely post its strongest annual growth since 2000, but still lag behind the US and other G7 economies.
US: The Biden Era Begins CHART 3: SURGE IN SAVINGS TO HELP
• Consumers are expected to be the dominant contributor to growth. SPENDING THIS YEAR
35
Household balance sheets are healthy, having delevered coming out of the
GFC, and aggregate savings have built up. Similarly, businesses will also 30
% of Personal Disposable Income
benefit from the low costs of borrowing but additionally will see a surge in 25
production from replenishing low inventory levels. Operating efficiencies
20
will improve through investments in automation. One growing risk is the
US-China relationship (see more below). However, this bodes well for 15
companies looking to reshore production back to the US, retool supply 10
chains, and develop redundancies and security of supply and essential
5
goods, all of which will further stimulate investment.
• The new US Administration comes in with high expectations for fiscal 0
1959 1965 1971 1977 1983 1989 1995 2001 2007 2013 2019
stimulus, fewer trade tensions and more multilateralism in its dealings.
Source: U.S. Bureau of Economic Analysis (BEA)
For growth, the Democratic control over the Executive, House and Senate
imply less legislative gridlock leading to more stimulus, infrastructure
spending and health care initiatives. A US$900 stimulus package was passed during the last week of December, which is
estimated to add some 2 percentage points to growth this year, while expectations are building for another package in the spring.
One negative offset to the bullish outlook arises from a possible increase in tax rates, for both corporations and individuals. However,
the environment in which President Biden will lead is different from the true “Blue Wave” given the narrowest of margins in the
Senate, and any excessively progressive policies are unlikely to make it through. So higher spending is likely, but not huge tax hikes.
FORECAST 2021 | Page 2EU: Steps to Fiscal Unity CHART 4: PERIPHERAL SPREADS COMPRESSING
• The European Union heeded Winston Churchill’s words from World War 4
II in trying to set up the United Nations - never let a crisis go to waste. 10Y yield spread versus Germany
The massive government solutions to the hardships brought on by the
3
shutdowns to combat the virus finally broke the barrier to a fiscal union. The
two largest governments committed to supporting collective borrowing
Percent
under the EU banner in the form of the EUR672.5 billion Recovery and 2
Resilience Facility. Its mutual debt will be bought by the European Central
Bank (ECB), effectively paving a smoother path forward for the common
1
currency. Like many in the world, Europe has rejected fiscal austerity, and
government support should smooth the outlook. Italy Spain
0
• More immediately, the region has been hit hard and the winter months 2018 2019 2020 2021
will flatline growth. Yet, the stunning 12.6% quarter over quarter (not
Source: Macrobond
annualized) third quarter rebound last year showed how much room there
is to bounce back once the public health outlook stabilizes. Numerous
national elections are slated over the next year, including Germany, Netherlands, France and Italy, which point to political risk.
Nonetheless, the outlook is, all things considered, considerably brighter. In addition to fiscal unity, Trump’s trade tariffs will be reduced
and higher longer term rates will lessen pressure on the banking system. Finally, both China and the US are interested in drawing
Europe closer, both commercially and in the area of international cooperation.
China: First In, First Out CHART 5: CHINA TRADE HAS REBOUNDED
WITH DEMAND FOR GOODS
• China was the first to succumb to the virus, first to recover through
25
aggressive lockdowns and first to see a full V-shaped recovery in its
20
economy. It has done so without excessive leveraging. Thus, the
15
combination of the virus’ fortuitous timing to hit early in the year, heavy-
Year/Year % Change
10
handed shutdowns, as well as the rebound in manufacturing, implies that
5
China will likely be the only major economy to post a gain in GDP this
0
past year.
-5
• This will likely ease in 2021. Part of the turbo gains in the second half 2020
-10
arose from China’s position as one of the world’s leading manufacturers of China Imports
-15
things needed to sustain working from and staying at home – electronics, China Exports
-20
housewares, toys and games. Exports have been a source of strength, rising 2015 2016 2017 2018 2019 2020
12%-21% year over year across various major Asian exporting nations.
Source: China Customs Statistics Information Center (CCS), Macrobond
However, easing in spending on goods, combined with appreciating
currencies will diminish trade activity. Policy will also look to normalize
credit growth downward and renew focus on excessive debt levels. Nonetheless, we believe that private domestic spending can
pick up the slack, particularly with wealth effects and global growth. With stronger global economic activity and marginal policy
tightening, China’s GDP will be positive, but will moderate through the coming year.
FORECAST 2021 | Page 3RISKS TO OUR OUTLOOK
As we consider the widely held consensus view that the coming year will be characterized by solid growth, the risks seem minimal.
While our base case forecasts are held with a high probability of coming to pass, it is at these times in particular when the not-so-
obvious risks should be monitored. The first two risks that we highlight below are medium term in nature, and not projected to
influence our near-term investment horizon. Over the next year, a resurgence in health risks undoubtedly remains the top concern.
1. Sustained Inflation Comes to Bear Quickly
CHART 6: NOW INFLATION TARGETING IS
• Perhaps the most dominant reason for the short-lived decline and forceful FLEXIBLE
14
recovery in economic activity and market indicators were the mammoth US Core CPI (ex-food, energy)
accommodative policy measures. It follows then that the greatest risk to 12
the outlook is a premature withdrawal of policy. To provoke that kind of
10
Year/Year % Change
extraordinary pullback in policy requires a threat, given the impact of the
8
pandemic-closures are still widespread and require support. The most
Inflation
likely such trigger would be inflation. 6
targeting era
• In our eyes, this is unlikely in 2021. Any jump in inflation measures would 4
most likely be (rightly) written off as base effects. To be sure, households
2
have a potent combination of high savings and pent-up demand, and
0
there are evident bottlenecks throughout the supply chain. However,
1958 1968 1978 1988 1998 2008 2018
an actual sustained pace of inflation that would elicit a policy response
requires that economies close the gap to their potential output, and this Source: US Bureau of Labour Statistics, Macrobond
is not a scenario we envisage for at least a year.
• One further factor dampens the potential for a surprise policy tightening. This past year saw perhaps the single most important shift
in central bank policy since inflation targeting began in 1991. In August, the Fed committed to Flexible Average Inflation Targeting
(FAIT), over a non-descript time and unclear level, thereby allowing the Fed the widest flexibility in policy setting. Central banks,
recognizing the risk that their policies are less effective when interest rates are near the zero-bound while debt levels have been
built up, would likely cheer a normalization in inflation expectations. They will therefore resist any instinct to tighten, and remain
steadfastly accommodative. Indeed, governments, on the side, may well quietly encourage this, recognizing inflation is an effective
way to pay for the enormous debt load they have accumulated.
2. The Divide Between China and the US Widens
CHART 7: A SHIFT IN THINKING ON CHINA-US
• In the US, there has been a consensus building that there is no longer RELATIONS
benefit from “constructive engagement” with China and that the two 210
China Geopolitical Uncertainty Index,
countries are competitors. Similarly, in China, there is a recognition 190 smoothed 6-months
of the need to decouple their input sources from the US. The division 170
has become clearer and the impacts will be wide-ranging, including on
150
technology, defense, communications, capital markets, climate and health
Index
130
care. As an example, access to capital is being tightened; the NYSE has
delisted Chinese companies and investment in these companies will need 110
to move into new hands as China’s capital markets will need to absorb the 90
repatriation of those listings. More importantly, however, the digitization 70
of our everyday lives, from appliances in homes, cars and mobile devices
50
and always-on communication implies that semiconductors remain a vital 2010 2012 2014 2016 2018 2020
commodity of the future; much of these are produced in Taiwan. This Source: Economic Policy Uncertainty, Macrobond
geopolitical battleground will become critical. Interestingly, where China
and the US do agree, is tighter tech regulations, on the fintech sector in
China and on social media and big tech monopolies in the US.
FORECAST 2021 | Page 4The net result of the decline in cooperation is likely slower overall economic growth and higher inflation. Furthermore, there will likely
be more jockeying and maneuvering as they try to grow their respective spheres of international influence and leadership. It is in that
light that it’s worth noting trade deals are coming together that realign commercial interests. Two examples from the last couple of
months alone highlight this. In Asia, a new Regional Comprehensive Economic Partnership trade agreement, under negotiation for
nine years and signed in November 2020, now links the ASEAN economies with China, Japan and South Korea in a massive free trade
area. Additionally, the recent Comprehensive Agreement on Investment, signed December 30, 2020, opens Chinese markets to the
EU and commits to sustainable development provisions.
3. The Virus or Vaccines Trigger a Serious Growth Scare
• It is almost superfluous to mention an unpredictable exogenous shock in any risk scenario in any given year. Yet, it was the dominant
influence over the world last year. As a result, we must be cognizant of potential risks related to our main near-term risk to growth,
such as mutations to the virus, or some problem that renders vaccines mute. At the moment, there is no indication that this will
come to pass.
• Indeed, the scientific community has demonstrated an extraordinary ability to study, sequence and combat a novel virus, and
so while a devastating strain or ineffective medical response is a risk, we are unlikely to repeat the all-encompassing shutdowns
and associated 30%+ equity correction that we had in spring 2020. Indeed, these current shutdowns over the winter have been
associated with steadier (though occasionally negative) employment, income, spending and industrial production activity. The
economic impact diminishes in each subsequent virus infection wave, as governments learn and attempt to target shutdowns to
manage outbreaks.
FORECAST 2021 | Page 5THE SECULAR ENVIRONMENT
Last year, we introduced three major changes to our secular themes that each signifies higher inflation – rising populism / reversal of
globalization; monetary policy ineffectiveness; and ESG investing. Each of these is still acutely relevant. The rise in income stagnation
and income inequality have been themes for a couple of years, and were joined last year by the likely reshoring of production and
supply chains. The probable outcome is higher prices. Second, the effectiveness of monetary policy becomes asymmetric as interest
rates are bound to the downside, while spending becomes restrained as debt levels accumulate. Finally, climate change and the desire
to invest in ways that positively impact society are gaining momentum with more investors advocating for sustainable investment
approaches. Over the past year, much has changed in the way we live and work, and this has significant implications for the investment
environment. We have discussed this over the year in Outlook. We highlight below two secular themes that we believe have lasting
implications for capital markets, in particular counteracting the upward pressure to an inflation-induced rise in interest rates.
1. High Debt Levels Precipitate Financial Repression CHART 8: TRAPPED WITH LOW RATES AS DEBT
LEVELS SURGE
• From businesses to households, debt levels have risen in recent decades 16 160
in response to spending supported by more attractive costs of financing. 14
2Y Bond Yield, left
Government Debt as % of GDP, right 140
This past year, we now add governments the world over. Given not only 12
120
the growth in debt this year, but also the likelihood that this will persist in 10
Percent of GDP
the next cycle, policymakers will look to enact policies that will ease the 8 100
Percent
burden of having to pay back that debt by running surpluses in the future. 6 80
These include growing GDP to reduce the proportion of debt as a size 4
60
of their economy, or perhaps more enticingly, inflating their way out of 2
debt by paying down debt issued today with inflated (devalued) dollars 0
40
of tomorrow. -2 20
1982 1986 1990 1994 1998 2002 2006 2010 2014 2018
• Government interventions, in markets and monetary policy, which lead
Source: The Bank for International Settlements, Macrobond
to a capping of interest rates below nominal GDP are likely to remain in
Note: 2Y Bond Yield is average of US, UK, Japan, Germany, France, Spain, Italy.
place for some time. By requiring institutions (life insurers, banks, mutual Government Debt as % of GDP is average of US, Japan, Eurozone, UK
funds and their own central banks) to buy and hold government debt,
yields can remain low enough to sustain debt financing. In the process, it creates distortions, transferring wealth away from savers,
those who rely on higher yields for income, towards debtors. The market outcomes of financial repression include low, sometimes
negative interest rates if not in nominal terms then most certainly in inflation-adjusted terms. Moreover, this also lends itself to higher
financial asset prices.
• Thus, the 40-year secular bull market in bonds may be over but we do not believe that we have entered an extended bear market
in fixed income assets.
CHART 9: LARGE DEFICITS TO EXTEND FOR YEARS
4
2. The Shift From Monetarism to Keynesianism US Budget Deficit (-) or Surplus (+)
2
• Prior to the pandemic, government debt levels in developed market 0
economies were already on a trajectory to grow materially based on -2
the committed health and retirement care expenditures that come with -4
Percent of GDP
aging demographics. Suddenly last year, previously inconceivable and -6
-8
“unprecedented” amounts of transfers and spending were enacted. Now
-10
running large government deficits is a state of life. Over the course of a
-12
year, unthinkably foolish government deficit spending is now thought of
-14
like an obligation to bring back sustained aggregate demand. This shift -16
in thinking has permeated countries, policymakers and different political -18
1962 1970 1978 1986 1994 2002 2010 2018 2026
stripes, quieting even fiscal conservative voices. This means fiscal policy
will become highly stimulative. As Milton Friedman once proclaimed: in Source: U.S. Congressional Budget Office (CBO), Macrobond
one sense, we are all Keynesians now. Note: 2020-2030 are projections prior to Biden administration fiscal plans
FORECAST 2021 | Page 6Equally important, zero interest rates are here not just for very short-term policy rates but all the way out the yield curve. This is
because quantitative easing, normalized after the GFC, is required to keep the cost of funding ultra-low. Therefore, the past three
decades of primary policy (inflation targeting) will now decline in importance. Even if inflation rises, central banks will resist raising
rates. This was formalized in FAIT by the Fed and likely to be considered by others including the Bank of Canada (BoC). In effect, the
Fed is no longer worried about inflation overshooting its target. Inflation is coming back and with only loose parameters defining over
what period and how long or far an overshoot will be tolerated, the Fed can keep policy accommodative. If inflation does come back,
propelled along by a strong fiscal push, central bankers are likely to take a kinder, softer view of it, implying a higher bar to raise interest
rates. Ultimately, this implies a longer path for accommodative policy.
FINANCIAL MARKETS CHART 10: EARNINGS TO TURN HIGHER WITH
IMPROVING ECONOMY
50
VALUATIONS AND TECHNICAL FACTORS S&P 500 S&P/TSX Composite
40
VALUATIONS: Earnings Growth Will Drive Returns 30
Year/Year % Change
• Corporate profits took a significant hit in 2020, as many businesses 20
were forced to shut down or significantly scale back operations due to 10
pandemic-related restrictions and lockdowns. The collapse in earnings
0
was swift, but was met with a solid rebound in the second half.
-10
• The backdrop for earnings is supportive heading into 2021, given
-20
widespread vaccine administration and ongoing accommodative policy.
-30
Economic activity should normalize, and we expect continued sequential 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
improvement in the level of company earnings that ultimately closes the
Source: I/B/E/S, TD Securities, Macrobond
gap created in 2020, prior to making new highs in 2022. A US Democratic
Congress adds to the risk of a corporate tax hike that could lower earnings
projections. However, it also raises the likelihood of additional stimulus that could drive earnings higher by enough to offset tax
burdens. In the US, we anticipate 28% growth in EPS from current levels in 2021, and a further 11% increase in 2022. In Canada,
which is more levered to the economic cycle, we expect a 36% increase in EPS in 2021, with a subsequent 12% rise in 2022.
• Profit margins contracted sharply in 2020. Margins are set to recover in 2021, as low interest costs persist and cost-cutting measures
implemented during the pandemic remain in place. Moreover, tight inventories could give firms some pricing power. Any rise in
input costs is likely able to be passed through to consumers, and should not prevent margin expansion. We do not expect this cycle
to differ from any other in terms of positive operating leverage that surprises to the upside at the start of the cycle as revenues recover.
• S&P 500 consensus for 2021 suggests earnings growth of 26% to $173 per share. For the S&P/TSX Composite, consensus calls for
an increase of 30% to $1016 per share. Our forecast for the US, at $176 per share for 2021, is roughly in line with consensus. We
believe markets will place more weighting on 2022 earnings, which we estimate to be $196 per share. In Canada, our forecast is
higher than market expectations at $1070 per share in 2021, and rises to $1196 in 2022.
FORECAST 2021 | Page 7VALUATIONS: Multiples to Remain Elevated CHART 11: VALUATIONS EXPECTED TO REMAIN
• Expansion in valuation multiples more than compensated for the earnings STABLE AT HIGH LEVELS
28
decline in 2020, with price-to-earnings ratios (P/Es) rising to levels last S&P 500 S&P/TSX Composite
26
seen during the tech bubble 20 years ago. We expect some multiple
24
contraction from these extreme levels, particularly in the US, but also
22
Forward P/E Multiple
believe that multiples will remain elevated, near the upper bound of the
20
post-crisis range, given the easy monetary conditions and tame inflation.
18
We expect interest rates to rise in 2021, but we believe there is room 16
for the equity risk premium to fall further, so long as the low volatility 14
environment persists. This allows for equity multiples to remain elevated. 12
• Consensus estimates call for earnings per share for the S&P 500 and the 10
S&P/TSX Composite to come in at $173 and $1016 respectively. The 8
2000 2004 2008 2012 2016 2020
consensus P/E multiple of 23.4 times for S&P 500 earnings 18.1 times for
Source: I/B/E/S, Connor Clark & Lunn Investment Management
S&P/TSX earnings suggest the S&P 500 around 4,050 and the S&P/TSX
should trade around 18,400.
• Our estimates are a touch more optimistic for the S&P 500, for which we use our 2022 earnings forecast of $196 and a P/E multiple
of 21 times, to achieve an index target of roughly 4,100. For the S&P/TSX, our 2022 forecast of $1,196, combined with a P/E multiple
of 16.8 produces an index level around 20,100. Overall, we expect an 11% increase in the US equity market and a 15% increase in
Canadian equities, in local currencies, from year-end levels.
VALUATIONS: Bonds Are as Overvalued as Ever
CHART 12: BOND VALUATION
• The CC&L Fundamental Bond Valuation Models (I & II) suggest a fair PERSISTENTLY EXPENSIVE
value range for the US 10-Year Treasury yield is 2.3% to 4.3%. Our 2
Bonds Cheap
CC&L Technical Bond Valuation Model has improved from the record
1
low (expensive levels) reached in March 2020, but is still indicating an
extremely overvalued bond market. The US 10-year yield ended 2020 0
at 0.90%, over 100 basis points below what was already considered a
Index
-1
low yield at the end of 2019. It was a historic year for global liquidity Bonds Expensive
with central bank balance sheets surging to all-time highs in record time, -2
widening the gap between fundamentals and asset prices.
-3
• While short-term bond yields will remain anchored near current levels, CC&L Bond Valuation Model
longer-term yields will face upward pressure given the rosier economic -4
1989 1994 1999 2004 2009 2014 2019
outlook and firming (although not sustained) inflation. Though we expect
long-term yields to rise in 2021, they will remain below what fair value Source: Connor, Clark & Lunn Investment Management Ltd.
models suggest.
FORECAST 2021 | Page 8TECHNICALS
Technical models are currently producing a wide range of signals. Out of nine technical models that we monitor, three are returning a
positive signal, three are negative and three are neutral. Momentum indicators are overall flashing positive, suggesting a continuation
of the favourable trend seen in equity markets in the latter half of 2020. In contrast, equity sentiment indicators are generating a
negative signal on net. Sentiment indicators are highlighting extreme investor optimism (a contrarian indicator). While two of the
four sentiment indicators are actually negative, the remaining two are near extreme levels. In aggregate, the signals from the technical
models are relatively dispersed, suggesting a neutral signal overall.
Table 1: Technicals Table 2: Financial Markets Forecast
Technical Models Score Market Forecasts Current Base Case Range over Next Year
50 & 200 Day Moving Average (5 markets) Positive Global GDP 5.5% 4.5%-6.5%
Citigroup Surprise Index Negative S&P Earnings ($ US) 137 176
Coppock Momentum Positive S&P P/E (x) 22.8 21
CC&L AMSD model Neutral S&P/TSX Earnings ($CA) 784 1070
Total Return Log (S&P/TSX & S&P 500) Positive S&P/TSX P/E (x) 16.9 16.8
Investors Intelligence Bulls & Bears Negative BoC Rate 0.25% 0.10%-0.25%
American Association of Individual Investors Bulls/(Bulls + Bears) Neutral CAN 10-Year Rate 1.10% 0.35% -1.45%
Bank of America Merrill Lynch Bull/Bear Neutral CAN Credit Spreads 1.40% 1.25%-1.90%
Citi Panic/Euphoria Model Negative
CHART 13: INVESTOR SENTIMENT BULLISH - EXHIBIT I CHART 14: INVESTOR SENTIMENT BULLISH - EXHIBIT II
1.8
7.1 LATEST 1.5
1.2
0.9
Euphoria
0.6
Composite
4 6 0.3
March 2020 2 8 0.0
Buy Sell
0.0 -0.3
Extreme 0 10 Extreme -0.6 Panic
Bearish Bullish -0.9
1988 1991 1994 1997 2000 2003 2006 2009 2012 2015 2018 2021
Source: BofA Global Investment Strategy
Note: As of Jan 2021 Source: Citigroup
CHART 15: INVESTOR SENTIMENT BULLISH - EXHIBIT III CHART 16: WORLD EQUITY MOMENTUM SHOWING
80 OPTIMISTIC SIGNAL
Excessive Optimism 2,200
(Negative Signal) MSCI World Price Index
70 2,000
MSCI World Price Index, 50-Day Moving Average
1,800 MSCI World Price Index, 200-Day Moving Average
60
1,600
Percent
Index
50 1,400
1,200
40
1,000
30 Excessive Pessimism
(Positive Signal) Investor Sentiment, Proportion Bullish/ 800
(Bullish + Bearish), 3-Week Moving Average
600
20
2010 2012 2014 2016 2018 2020
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Source: American Association of Individual Investors, Macrobond Source: MSCI Barra
FORECAST 2021 | Page 9PORTFOLIO STRATEGY AND STRUCTURE
This past year marks the third straight year where global economies have disconnected from financial market performance. In the last
twelve months, global equity markets (MSCI ACWI) posted double-digit gains, the Canadian universe bond market index returned
just under 9%, and commodities, excluding energy also gained 10%, all during the worst global recession since the Great Depression.
Central banks have driven a wedge between the traditional positive correlation between economic growth and financial market
performance, by flooding the financial system with liquidity.
Our technical models are sending disperse signals, as momentum indicators are generally positive but key sentiment indicators (a
contrarian signal) have turned overly optimistic. To date in this market rally, equity valuations have done all the work of the equity rally,
and looking forward, markets will demand earnings growth to sustain the gains. We do think there is a strong case for both earnings
and margin growth. One key risk for equities remains higher yields. From our lens, some normalization of the equity risk premium,
combined with a modest increase in risk-free 10-year sovereign bond yields, will still create conditions for favourable valuations.
Indeed, within a higher rates scenario, fundamentals for some value-oriented sectors, like banks, will look rosier.
Bonds have been expensive for a decade, and as interest rates dropped across the yield curve, fixed income assets only got more
expensive this past year; we do not see this changing yet. On the upside, negative yields are unlikely to come to North America.
However, the path of rates will become less clear when sustained inflation returns. On net, we expect yields to rise modestly but
remain capped well below 2.0%. Credit markets have been spared a material default cycle with central bank support for corporate
debt. However, after the nine-month rally, all-in yields are at or below their pre-pandemic levels and spreads do not look to provide
much value. Still, the overwhelming search for yield and return will keep both high-grade and high-yield credit well supported and
we still see further gains here. Finally, the asset mix within balanced portfolios remains firmly tilted in favour of equities, and is aligned
with our constructive outlook.
CHART 17: EQUITIES SET FOR ANOTHER
STRONG YEAR
Asset Class Returns 70
• We are bullish on Canadian, US and global equities, as continued 60 S&P/TSX Composite Total Return Index
FTSE Canada Universe Bond Index
improvement in the broad economy will lift earnings expectations. In 50
early cycle periods, those companies, sectors and regions that are the 40
Year/Year % Change
30
most leveraged to growth tend to outperform. Building on last year’s
20
gains, we anticipate a gain of 11% for US equities and a slightly higher
10
return of 15% for the S&P/TSX Composite. Europe and emerging markets 0
(EM) could see gains similar to those in Canada. The former looks set to -10
benefit from a modest normalization in the yield curve that is positive -20
for banks, while EM will benefit from the rotation to early cycle sectors -30
(industrials and commodities). -40
1989 1994 1999 2004 2009 2014 2019
• Our base case is for the 10-year Government of Canada bond yield to Source: Toronto Stock Exchange, FTSE Global Debt Capital Markets, Macrobond
rise gently through this year, trading off the lows seen last year and in the
range of 1.1% to 1.25%. Given our outlook (and consensus) for inflation
expectations to return over the coming years, the risks for interest rates are tilted to the upside. The BoC, aggregate Canadian debt
levels, and a large output gap will likely limit any material upside above 1.5% in the near term. As such, we expect total returns for
the FTSE Canada Universe Bond Index to be muted, and only near its running yield of 1.2%.
• Our asset mix strategy favours global and Canadian equities in equal measure, as the downside headline and economic risks abate.
We maintain an underweight in bonds after the run-up in prices in the wake of the global deflation scare last year. We believe the
environment of accommodative policy will extend for some time, leaving us constructive on risk assets.
FORECAST 2021 | Page 10Stock and Sector Selection
CHART 18: CYCLICAL SECTORS TO DRIVE 2021
• Despite our constructive outlook for stocks, the upcoming year will be EARNINGS GROWTH
characterized more by a change in leadership, in comparison to the 2020 70%
63%
experience. In a shift from prior years, our fundamental equity portfolios Cyclical Sectors
60%
Consensus EPS Growth Expectations
Defensive Sectors
have rotated from bond proxy sectors, such as consumer staples, utilities
and telecommunication companies, into cyclical and more value oriented 50%
stocks, which typically do well at the start of a new cycle. 40%
40%
• Thematically we believe that global fiscal stimulus will have a significant 30%
impact on equity performance in 2021 and 2022. We expect fiscal stimulus
20%
will be very supportive for infrastructure spending, domestication of 14%
supply chains, health care, education and ESG investing with a focus on 10% 7%
reversing climate change. Extending a secular theme from last year, we
0%
expect that valuation multiples on renewable stocks and alternative fuel S&P/TSX Composite S&P 500
stocks, such as hydrogen and electric vehicles, will see multiple expansion Source: TD Securities, Goldman Sachs Global Research
while valuations for companies that are associated with polluting fuels will
see multiple contraction.
• Our views for equities in the US account for the change in the balance of power in the Senate, with the win by the Democrats in the
Georgia runoffs. This lays forward a path for a more progressive agenda, but only modestly so, given the razor thin control over the
Senate and net loss of seats in the House. The net impact on earnings in 2021 will be positive, as any corporate tax increases will
occur later in the year, while the new Administration will introduce further stimulus early in the year. The full impact of any corporate
tax hikes will be felt more on 2022 earnings.
Corporate Credit CHART 19: CORPORATE CREDIT STILL LOOKS
ATTRACTIVE
• In this low-yielding environment, investors everywhere are looking for a 450
safer place to find some marginal returns. Thus, a yield pickup of about 150 400
FTSE Canada Corporate IG Spread
bps over sovereign bonds looks pretty compelling. In addition, an early
350
cycle environment with rising earnings, and companies that on the whole
300
have strong balance sheets suggests that corporate credit looks attractive.
Basis Points
The liquidity backdrop is also favourable. The ECB and Bank of Japan have 250
long been supporters of higher risk assets, but the Fed and BoC have joined 200
this past year by rolling out programs that support corporate investment 150
grade and provincial bonds in the event of a sharp deterioration in market 100
liquidity and funding. However, the overall level of credit spreads does
50
look like it is close to fully reflecting our forecasted levels. 2004 2006 2008 2010 2012 2014 2016 2018 2020
• Moving forward, our credit strategy will continue to be focused on Source: FTSE Global Debt Capital Markets Inc., Connor, Clark & Lunn
Investment Management Ltd.
higher quality companies, but with some yield advantage further down
the capital structure. Canadian Bank Alternative Tier 1 debt is an example
where marginal added risk is limited relative to its spread gain. Telecom issuers are also favoured for the structural demands for both
work and entertainment that make our devices and home connectivity indispensable. The risks around credit remain low overall, so
we maintain an overweight in fixed income portfolios, for now.
FORECAST 2021 | Page 11Duration and Yield Curve
• Canada’s nominal and real yields dropped last year alongside those in
CHART 20: ROOM FOR CONTINUED STEEPENING
the rest of the world; policy rates were cut 150 bps in March alone. Our
3.0
short-term interest rates will remain anchored at zero for at least two full 10Y-2Y Yield Curve
years. However, the improvement in the macro environment will start to 2.5
compel central banks to moderate their quantitative easing purchases 2.0
before signaling interest rates need to rise. Moreover, a strong cyclical
1.5
backdrop will see longer-term rates drift higher, particularly as inflation
Percent
concerns creep into the market. 1.0
• Interest rates are likely to climb from here. Nonetheless, financial repression 0.5
limits how high rates can go. We believe rates are in an uptrend from here, 0.0
but at a gentle slope. The mass of negative yielding global debt also acts
-0.5
as an anchor to Canadian yields surging too far. As a result, duration in 1995 2000 2005 2010 2015 2020
bond portfolios will be traded tactically, with a bias to the shorter side.
The yield curve has room to steepen, with any shift in yields likely to be Source: Bank of Canada, Macrobond, Connor, Clark & Lunn Investment
Management Ltd.
expressed at the longer-end of the curve only. Typically, yield curves can
steepen 200 bps or more out of a recession. That is not likely this year.
• One additional area in which we continue to see value and a good hedge against inflation are in Real Return Bonds (RRBs) in Canada.
The 30-year break-even inflation rates are closing the year at about 1.5%, and some 50 bps below their US counterparts, despite
support from the BoC.
Table 3: Scorecard (Macro Inputs)
Economy Monetary Inflation Valuation Technicals Total
US + + + N - +
Canada + + + N + +
Europe + + + N/A N +
China/EM N N + N/A N/A +
Total + + + N N +
+ Positive; – Negative; N Neutral; N/A Not applicable
FORECAST 2021 | Page 12SUMMARY
Our 2021 forecast is optimistic as we expect to see a pervasive reversal of much of what went wrong in 2020. We will see the rollout
of COVID-19 vaccines combat the effects of the virus; economies will gradually reopen from the isolating lockdowns; countries,
governments, businesses and households will benefit from an economic recovery after the deep recession; and equity market leadership
will broaden as investors rotate towards companies that will benefit from the coming inflationary landscape. It is likely to be a year of
solid growth, sharp earnings rebound, stable valuations, US equity underperformance vs. Canadian and global markets and pressure
on yield curves to steepen modestly. The US is divided but will look to unite at home and abroad. China will moderate and look for
ways to become independent of the US. Europe may see a period of growth having now laid in the fiscal brick of the foundation that
builds the common currency. The secular themes continue to shift towards a pro-inflation outlook, though the debt supercycle remains
an ever-present and ever-growing concern. We have also learned an important lesson, that central banks and fiscal policymakers have
demonstrated very little tolerance for shocks and do have the firepower to avoid a financial and banking crisis. For now, as we move to
put the current virus-related hardships behind us, the economic outlook for the year ahead is bright. We remain optimistic for higher
equity and credit markets, a rebound in early-cycle stocks, a weaker US dollar, and strengthening commodity prices.
This report may contain information obtained from third parties including: Merrill Lynch, Pierce, Fenner & Smith Incorporated (BofAML), S&P Global Ratings, and MSCI.
Source: Merrill Lynch, Pierce, Fenner & Smith Incorporated (BofAML), used with permission. BofAML permits use of the BofAML indices related data on an “As Is” basis, makes
no warranties regarding same, does not guarantee the suitability, quality, accuracy, timeliness, and/or completeness of the BofAML indices or any data included in, related to, or
derived therefrom, assumes no liability in connection with the use of the foregoing, and does not sponsor, endorse, or recommend Connor, Clark & Lunn Investment Management
Ltd. or any of its products.
This may contain information obtained from third parties, including ratings from credit ratings agencies such as S&P Global Ratings. Reproduction and distribution of third party
content in any form is prohibited except with the prior written permission of the related third party. Third party content providers do not guarantee the accuracy, completeness,
timeliness or availability of any information, including ratings, and are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, or for
the results obtained from the use of such content. THIRD PARTY CONTENT PROVIDERS GIVE NO EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY
WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE. THIRD PARTY CONTENT PROVIDERS SHALL NOT BE LIABLE FOR ANY DIRECT, INDIRECT,
INCIDENTAL, EXEMPLARY, COMPENSATORY, PUNITIVE, SPECIAL OR CONSEQUENTIAL DAMAGES, COSTS, EXPENSES, LEGAL FEES, OR LOSSES (INCLUDING LOST INCOME OR PROFITS
AND OPPORTUNITY COSTS OR LOSSES CAUSED BY NEGLIGENCE) IN CONNECTION WITH ANY USE OF THEIR CONTENT, INCLUDING RATINGS. Credit ratings are statements of
opinions and are not statements of fact or recommendations to purchase, hold or sell securities. They do not address the suitability of securities or the suitability of securities for
investment purposes, and should not be relied on as investment advice.
Source: MSCI. The MSCI information may only be used for your internal use, may not be reproduced or redisseminated in any form and may not be used as a basis for or a
component of any financial instruments or products or indices. MSCI makes no express or implied warranties or implied warranties or representations and shall have no liability
whatsoever with respect to any MSCI data contained herein. This report is not approved, reviewed or produced by MSCI.
FORECAST 2021 | Page 13Vancouver Toronto 2300 - 1111 West Georgia Street, 1400 - 130 King Steet West, P.O. Box 240 Vancouver, BC V6E 4M3 Toronto, ON M5X 1C8 604-685-2020 416-862-2020 www.cclinvest.com A CONNOR, CLARK & LUNN FINANCIAL GROUP COMPANY
You can also read
