In the last newsletter I wrote a few months ago (March 2021… Time flies!), I commented on the strong economic rebound we saw and also my thoughts on low interest rates and rising inflation. I made the case for why high-quality equities is and has always been one of the best ways to combat inflation.

Furthermore, I discussed the current risks involved with cash and fixed income. Cash has been devaluing faster than previously and bonds are exposed to interest rate risk (bond values go down when rates go up). Equities, through all the world’s fads and fears and economic cycles over the past 100+ years, are on a constantly-rising trend line but with temporary speed bumps or potholes. The keys to successful investing are to diversify well and to buy companies based on their fundamentals rather than based on their short-term price fluctuations.

If you missed it, feel free to read it by clicking on the link below:

https://ca.rbcwealthmanagement.com/alexander.petrov/blog/2868698-Rebond-conomique-fort-taux-bas-hausse-des-prix-avenir-prometteur-Pour-certains--Strong-economic-rebound-low-rates-rising-prices-a-bright-future-For-some

Much of what I shared has materialized so far this year and clients have benefited from implementing my recommendations. Equities have delivered strong returns in 2021 so far despite a speed bump in the tech sector early in the year.

I am sharing below the most recent commentary of Jim Allworth, one of the chief economists of RBC Dominion Securities. This commentary below outlines the current state of the equity markets, fixed income markets, the economy and currencies.

Equity Markets

The outlook for the remainder of 2021 and for 2022 has not fundamentally changed. We expect all of the developed economies, led by the US, will post above-average GDP growth compared to last year’s slump. Absent a vigorous return of the pandemic, the momentum provided by repeated applications of fiscal stimulus from governments – supported by entrenched accommodative monetary policies – should keep most economies powering through next year and probably beyond. Robust growth this year followed by slower, but still above-average growth next year looks to be the likely outcome.

For the important US economy, all six of the reliable leading indicators of recession we track are giving the economy a decisive green light. The next recession, when it eventually arrives, will likely be triggered the good old-fashioned way – by a tightening of credit conditions sufficient to make interest rates prohibitively expensive and banks more cautious about lending. However, no tightening of that magnitude appears to be nearby.

Recessions matter for the equity investor because they have always formed the economic backdrop associated with bear markets. As yet, and probably for some time, no recessions appears on the horizon. Factors that support this view include:

• Most economies are reopening as the vaccine rollout diminishes the impact of the pandemic;

• Earnings are very strong (GDP-based US corporate profits are already above their pre-pandemic peak)and forward-year earnings estimates have been revised sharply higher over the past six months (S&P 500 by 15% and TSX by 13%);

• CEO confidence, as measured by the Conference Board, is at an 18-year high, while business confidence is high and rising in Germany, France and Canada, improving in the UK and Japan;

• Corporate bond yields remain very low and access to credit plentiful; and

• Capital spending is booming, which is good news for productivity and inflation.

Corrections, as distinct from longer, more painful bear markets, are a fact of life for equity investors. Rising inflation and Biden’s plan to raise corporate tax rates are two things among many that could trigger bouts of market volatility. However, at this point, the kinds of developments that would indicate something worse than correction is in the offing are not in evidence.

We expect equity prices will appreciate further from today’s levels through 2021, although not as much as earnings advance, bringing price-to-earnings ratios down modestly.

Fixed Income Markets

Central banks, led by the Fed and including the Bank of Canada, are committed to ultralow short-term interest rates for some time yet – The BoC has tentatively targeted next year for a first rate hike, the Fed not until 2023. Both have indicated they will be tolerant of higher inflation as long as they remain convinced that this episode will be transitory and that reported inflation will subside later this year and into 2022.

We expect the US 10-year yield will move higher up into the range of 2.00% by the end of the year. Canadian bond yields will move higher in concert while short-term rates remain anchored by BoC policy. With longer-term rates forecast to rise, we favour shorter-term maturity for now but expect the market will present opportunities to lock in higher yields in the coming months.

Preferred shares have been among the best performing credit market category over the past 15 months, driven by the move higher in bond yields which has dramatically improved the “reset” prospect for these issues while tax changes for issuers have resulted in the redemption of a growing number of issues which has shrunk the market supporting prices. Selectivity is called for from here.

Currencies

US Dollar: Focus on tapering

The fed has been dovish throughout H1, but the June FMOC meeting has seen a change in tone with the median interest rate forecast indicating two hikes in 2023. Focus turns to the August Jackson Hole symposium, where there is likely to be a formal conversation on tapering at the event. We look for the comparatively higher US yields to keep the USD supported through H2, unless economic data in the US unexpectedly weakens.

Euro: ECB not ready to remove PEPP

The June ECB meeting underlined the importance of keeping pace of the PEPP, which contrasts to the Fed’s move towards tapering, expected early next year. This perceived monetary policy divergence, coupled with consensus growth forecasts that favor the US, should potentially see the EUR underperform the USD in H2 2021. One risk to this view however would be posed by a significant shirt from US to European equities.

Canadian dollar: All the hawkishness priced in?

A hawkish taper by the BoC in April, soaring commodity and crude oil prices have made the loonie the top performer in G-10 so far in 2021. Our RBC Capital Markets economists look for tapering intentions of the Fed to catch up to those of the BoC, resulting in a firmer USD/CAD in H2 2021.

British pound: Limited scope for further gains

The pound had a stronger performance in H1 2021, following a hawkish BOE and an impressive vaccine rollout in the UK. A lot of good news has however been priced in on the GBP and we look at further gains to be limited. Increasing tensions between the UK and EU regarding Northern Ireland will be something to watch over the coming months.

Asset Allocation

There is always potential for heightened volatility in both directions for equity markets but absent a resumption of the pandemic or an unexpected severe monetary tightening, we expect equity prices will appreciate further from today’s levels through 2021 and 2022 following earnings higher. We think a balanced portfolio should carry a moderate over-weight in equities.

We recommend a benchmark weighting in fixed income.

Petrov’s conclusion

Jim’s most recent commentary closely aligns with my own. We are optimistic about equities as long as they are bought based on their underlying fundamental qualities. Being fearful of equity markets has never been profitable and I would avoid trying to time the market. In our regular reviews, we look at how your portfolio is progressing relative to your financial plan and we ensure to utilize all of the tools in the toolkit.

If you have any questions, please feel free to contact my team and I and we will be happy to chat. If you think someone you know may be a good fit and could benefit from our guidance, please contact us to let us know and we can discuss.

Sincerely,

-Alex & The Petrov Wealth Management Group