One year later: Market oulook

Annamaria Testani (AT) and Martin Lefebvre (ML)

(AT)

Welcome everyone to our NBI Podcast. My name is Annamaria Testani. I am Senior Vice-President for National Bank Investments and I’m really happy to say today we have a wonderful guest, Martin Lefebvre, who is our Chief Investment Officer and comes with a wealth of information that is pretty interesting for many of us. Martin, welcome to our podcast!

(ML)

Hello Annamaria, I’m happy to be here with you guys today.

(AT)

You know what? I’m happy to say spring is gone, summer’s around the corner and now everything is opening up, so we’re very excited to hear what could this mean for a lot of us. You know before we start kind of sort of going into the future, let’s kind of sort of step back a bit. Martin, what would you say were good lessons learned from where we went through the last 12 months to where we are today, and you know, what’s your take about what we just lived with as far as where we’re going?

(ML)

Annamaria, I don’t know where to start to be precise because so much happened over the past 12 months as you well know. But one learning I would say was that never fight the fed, or never fight central banks.

(AT)

What does that mean though? What does that mean for the average investor?

(ML)

Well, we’re always trying to be ahead of the curve in terms of our positioning and trying to dictate what central banks should be doing but the fact of the matter is that they have the control, they’ve lowered interest rates to zero, they were quick to do so, they were also supported by governments because you know, once you bring interest rates to zero, there is only so much you can do to add stimulus to the pipeline. But they were well supported by governments that took over and now what we know if that from the market drop in March of last year, we’re up at a spectacular pace.

On a one-year period I think that the market had rebounded more that 75% so it’s really enormous what’s happened over the last couple of quarters even though for many people it feels like we’re still in crisis mode. But, a lot has happened, we’ve created a few vaccines, it was a fast inoculation of the population, and now we’re happy to say that Canada is a leader in all of that and will probably be able to reopen on a very broad base.

(AT)

Kind of sort of be proud about, right? Like, you’re proud about the fact that… but I think you know the lesson learned is: it’s not linear. So, when the market is bombarded by insecurities, and most of us don’t know what a pandemic meant, we’re accustomed to linear thinking. I think our lesson learned is there’s nothing linear about the way the market reacts, and the way suppliers can influence the market.

So, where are we today? Where does that leave us today when we’re looking at where we’re at and where we’re going?

(ML)

The markets have rebounded like I said very heftily and even that trend has continued since the beginning of the year. I guess the only soft spot has been in bonds because the bond market has reacted to all of this renewed optimism in the economy. I mean, growth, we went from, “Oh, it’s probably going to be the worst nightmare-type of scenario”  to, “Well, it seems like things are doing, you know, not so bad after all” because there was so much cash on the sidelines for so much time and the deployment of all of that is really finding a space to contribute to economic growth.

So, at the beginning of the year, we were expecting growth to be somewhere around 3%, 3.5% in North America. Now, it’s going to be north of 6%, so clearly, there’s been sort of a V-shaped recovery and just because of that it was abnormal to see interest rates remains at their abysmal levels back into where, you know, yields were just pre-pandemic, so somewhere around 1.5% and 2%. We think that will probably stay around that level for the near future. But, equities have done really well – you look at U.S. equities and we’re up 12% since the beginning of the year.

Canada is doing tremendously well because cyclical sectors have outperformed, some commodities are up, the energy sector is up, as well as small caps. There’s been a shift in the leadership from growth in infotech stocks towards cyclicals and value stocks since the beginning of the year. Although we believe there is still upside potential, there are still some very important risks to monitor going forward, Annamaria.

(AT)

So what I’m hearing is timing the market has never been a more valuable lesson that what we’ve lived in the last 15 months. Timing it would not have done us a service. To your point, it is so volatile, it is so risky, it does move, but it also does recover and grow and you can’t time it. So staying invested is probably one of the key lessons despite being told for 50 years to do it, this is a great example of doing it.

You mentioned something interesting, Martin, like you were alluding to risks, though. So far you’ve mentioned growth, 12%, like all these amazing numbers. What are the risks that could hit us and kind of sort of make us stumble.

(ML)

One of the fears in the market participants right now is that this is going to lead us to overeating. We’re already seeing bits and pieces of inflation materializing so the main risk is that –

(AT)

So how do we see it?

(ML)

We see it in the inflation numbers that have picked up a little bit, we know that some of that pickup in inflation is linked to what we call base effects. You know, recall at the same time 12 months ago, so a year ago, we were in deflation, right in the midst of the pandemic.

So now we’re kind of seeing the flipside of all of that. Inflation has picked up only because of base effects so that we knew that that was coming, but it’s been a little bit more that that because also there’s been some supply and demand imbalances, there’s a lot of cash right now trying to find its way to –

(AT)

So, you mentioned supply and demand imbalances. So for us, what does that mean. For us that are not living this every day, what does that look like?

(ML)

Well, it means we’ve got lots of cash, the economy is reopening and we’re willing to go out and spend all of that money, but because of the pandemic, there’s been supply disruptions like production has been hurt in many ways. Just to give you an example, semi-conductors: there’s a problem in finding semi-conductors which had a huge impact in the production of new vehicles in the U.S.

People have kind of had to go through a secondary market to get used cards and what we saw was a jump in month-over-month prices for used vehicles in the U.S. north of 10%. You never see that, usually. So, once semi-conductors are back on track and demand slows down a little bit, we’ll go back to some form of equilibrium. That’s why markets and central banks believe that this is more of a transitory phase that we’re facing right now, not really the beginning of something huge in terms of future inflation. We need to go through wages increasing at a constant pace for not only the next couple months but really a more durable phase of increase for wages in the U.S. and around the world.

(AT)

But would you say the risk is unexpected inflation or is the risk just that it’s a little bit higher inflation than we’ve been accustomed to the last three, four years? What’s the difference between either or?

(ML)

There’s a huge difference. So, what the central banks are telling us is that they’re willing to let inflation rise a little bit than what used to be a goal of 2%. Now, they’re willing to say that we want to see inflation on average at 2%, which means that from time-to-time inflation might be above 2%. It’s difficult to generate inflation. We know that in Japan, it was very difficult for them to get out of that crisis. We saw that in Europe as well over the past decade, it’s very difficult. Once the goal is to generate inflation, there’s so much downward pressure on prices coming from technology innovation, robotization, globalization, so we live that on a day-to-day basis and it’s really hampering any effort to generate inflation.

The key in all of that, and you’re exactly right, is expectation. So the only way markets or the population will be able to generate inflation is if it’s set in stone in everybody’s mind that there’s going to be inflation. I’ll give you an example: if you think of the housing market, it’s a good example for that, because right now you think that you’re ready to buy a house but you’re willing to wait to see if the price will go down. If you believe that price will go up then you’re probably –

(AT)

Pay more.

(ML)

– purchase that house right away instead of waiting for that same house to be 10% or 20% higher in the next couple of months. It’s the exact opposite of deflation, and deflation is when you think you need to buy a fridge but you can wait a little bit, like if there’s no emergency and you know that the price will drop week after week then you’ll probably wait for that price to be at the bottom. We’re kind of living a little bit of that phenomenon right now but for the time being what we’re seeing is that whether it’s market-based or consumer-based, expectations are that what we’re living right now will be transitory in nature.

(AT)

You know what’s very interesting and again, to your point, time is money. I think, you know, what I’m hearing from you since the beginning is time is money and staying on the sidelines does not do us much good compared to either consumption or an investment perspective.

We’ve had an interesting let’s say, 15 months, we’ve gone through an upheaval, the asset allocations come under pressure from a lot of different areas. Where do we go from here? When you’re looking at bonds and equities, what are things that we need to keep top of mind when we build portfolios and when we’re looking at how to communicate this back to clients?

(ML)

I think there have been a few lessons learned over the past couple of months. For one thing, I started in the intro telling you that it had been a tough quarter for bond investors with yields going from a low of 0.5% to 1 and ¾%, something like that. So, it was a huge capital loss that was incurred during that period, but it’s not game over for bonds.

We’ve learned over the past couple of weeks if not months is that the bond market is kind of stabilizing right now. Every bad news has been encompassed into where the yield is today but for as long as inflation is not getting out of hand, probably that bond yields will stabilize around the current level.

The federal reserve and most central banks have told us that they were willing to wait and be prudent in their approach to make sure that that employment gap – which is still huge, I mean, there’s still close to 8 million jobs that need to –

(AT)

Be filled.

(ML)

– be filled to be back where we were pre-pandemic, so that’s a huge pickup. Central banks will probably leave interest rates at the central bank for the foreseeable future until probably the end of 2022 if not even later than that.

Just because of that, we need to be prudent in reshuffling our portfolios hastily or something like that. That being said, we still feel that there is a lot more potential in the equity markets. I know some investors find they’re expensive at somewhere around 20 times forward earnings multiples, but the important thing here is what we call the equity risk premium, so once you take hold of the fact that interest rates are very low right now, historically low, the equity risk premium is still somewhere around 5%, and just because of that, I feel that investors continue to be well compensated for taking the risk in investing in the stock market.

And, Annamaria, you and I know that the stock market will be volatile and will continue to be volatile, there are going to be pullbacks here and there, if 5% if not even 10% some point in time, but if you’re invested in the long time horizon that is you know more than one year ahead of you, chances are the stock market will continue to give you great returns.

(AT)

All I’m hearing is exciting times ahead of us. I think again one of the risks is if we make it linear. There are a lot of moving parts. And I think, again, what’s really interesting about your role, you’re constantly interacting with a number of different companies within Canada, within the U.S., you’re looking at all of these factors, you’re looking at is the asset allocation arming you to have the best kind of sort of risk return for any portfolio as a whole.

The past is not an indication of the future but I think lessons learned are something that we tend to forget. We’re always busy trying to figure out what the next quarter brings us. What I’m hearing is, don’t assume linearity, don’t assume that expectations, like don’t get ahead of expectations, mitigate them, manage them properly, I’m hearing opportunity. You’re seeing beautiful opportunities going forward but it does come with potential volatility that will come along the way as new information hits the market.

I think the next couple of quarters are definitely something to stay invested in and look forward to seeing what comes of it. Thank you Martin, this has been honestly a very educational kind of sort of segment and of course my dog is agreeing with us because she definitely loves hearing your market updates. Who wouldn’t?! On that note, thank you for taking the time, and I look forward to talking to you in the coming weeks if not months.

Thank you everyone for going on our podcast, looking forward to hearing from you again in the near future, keep us posted and let us know what you’d like to hear next. Take care everyone.

(ML)

Bye bye.