Successfully reported this slideshow.
Your SlideShare is downloading. ×

2021 Nicola Wealth Strategic Outlook


Check these out next

1 of 75 Ad

2021 Nicola Wealth Strategic Outlook

Download to read offline

On April 28, we presented our Strategic Outlook in a new virtual format hosted by President David Sung, featuring presenters John Nicola, Chairman & CEO, and Rob Edel, Chief Investment Officer, for a look back at 2020, how the past 12 months have already shaped the economic landscape ahead of us and where do we go from here.

On April 28, we presented our Strategic Outlook in a new virtual format hosted by President David Sung, featuring presenters John Nicola, Chairman & CEO, and Rob Edel, Chief Investment Officer, for a look back at 2020, how the past 12 months have already shaped the economic landscape ahead of us and where do we go from here.


More Related Content

Slideshows for you (20)

Similar to 2021 Nicola Wealth Strategic Outlook (20)


Recently uploaded (20)


2021 Nicola Wealth Strategic Outlook

  1. 1. 2021 Strategic Outlook A Year In The Shadow of Covid-19 Hosted by David Sung, President
  2. 2. Quantitative Analysis of Investor Behaviour The Dalbar Study Source: Dalbar Quantitative Analysis of Investor Behavior, 2020. Returns as at Dec 2019 Average Asset Allocation Fund Investor S&P 500 Inflation 20 Year 2.54% 6.06% 2.14% +0.4%
  3. 3. 61% 37% 2% 0% XYZ Bank “Balanced” Asset Allocation Stocks Bonds Cash Other This, does not equal… This. Nicola Wealth – Beyond Stocks and Bonds
  4. 4. $0.00 $500,000.00 $1,000,000.00 $1,500,000.00 $2,000,000.00 $2,500,000.00 $3,000,000.00 $3,500,000.00 $4,000,000.00 $4,500,000.00 Dec-99 Sep-00 Jun-01 Mar-02 Dec-02 Sep-03 Jun-04 Mar-05 Dec-05 Sep-06 Jun-07 Mar-08 Dec-08 Sep-09 Jun-10 Mar-11 Dec-11 Sep-12 Jun-13 Mar-14 Dec-14 Sep-15 Jun-16 Mar-17 Dec-17 Sep-18 Jun-19 Mar-20 Dec-20 Nicola Core Performance (net of fees) 60/40 Model Portfolio (minus 1% management fee) S&P 500 (CAD) MSCI World (CAD) 6.96% 4.29% 6.13% 5.07% -2.67% ^ This is a blended benchmark of 4 indices minus 1% management fee: Citi World Government Bond, FTSE TMX DEX Universe Bond, MSCI World, S&P TSX Composite ^
  5. 5. & planning is an ongoing process… Everything starts with planning. Identify and discuss goals and objectives Investments Beyond Stocks & Bonds Retirement Income Modeling Tax reduction strategies Business structure & succession Planning Collaborative planning with your accountant and other advisors Charitable giving goals integrated with tax planning Review of insurance needs for business & family Will, Estate & legacy Planning Is your investment portfolio protected from volatility? Do you know how much capital you will require to meet your retirement goals? Have you considered how you will create your legacy? Is your insurance positioned as an asset class and integrated with your investment strategy? Have you prepared your family to manage this wealth? Have you reviewed loans and mortgages to reduce interest costs and determine whether any may be tax deductible? Do you have a succession plan in place? Is your plan being regularly reviewed and adjusted to ensure you’re on track?
  6. 6. 2021 Strategic Outlook Rob Edel, Chief Investment Officer
  7. 7. Our Agenda Investment Strategies Shape of the Recovery
  8. 8. Shape of the Recovery – Three scenarios Economic Growth Left Tail Too Cold Covid 3rd Wave Deflation Right Tail Too Hot Inflation Higher Rates Just Right “Goldilocks” Strong Growth Low Interest Rates Stimulative Fiscal BCA Research: Goldilocks and the two tails ?
  9. 9. Shape of the Recovery – Left Tail and the Pandemic Biden 100 million in 100 days Did 230 million Bloomberg – April 26, 2021 NYT – April 14, 2021 25% fully vaccinated 65% 65+yrs fully vaccinated 40% at least one jab 70% by June 8
  10. 10. Financial Times – April 9, 2021 Bloomberg – April 19, 2021 Shape of the Recovery – Left Tail and the Pandemic US still 60,000 New cases per day
  11. 11. How well do vaccines work? When will we all get it? Will we take it? Economist – Feb 12, 2021 Bloomberg – Mar 31, 2021 The Daily Shot – Mar 29, 2021 Variants B.1.1.7 - UK B.1.351 - South Africa* P.1 – Brazil B.1.617 – India* B.1.429 – California B.1.232 – California *Vaccine concerns Shape of the Recovery – Left Tail and the Pandemic Canada Leaders
  12. 12. Shape of the Recovery – Goldilocks “Just Right” #4!
  13. 13. Financial Times – April 14, 2021 Strategas – April 13, 2021 March Retail Spending +9.8% Shape of the Recovery – Goldilocks “Just Right”
  14. 14. Shape of the Recovery – Goldilocks “Just Right” S&P 500 S&P/TSX Mar 23, 2020 -34% Feb 20, 2020 Apr 26, 2020 +91% Feb 20, 2020 Mar 23, 2020 -37% Apr 26, 2020 +77%
  15. 15. Dovish Monetary Policy Record Fiscal Policy Shape of the Recovery – Goldilocks “Just Right”
  16. 16. BCA Research – April 1, 2021 March 23 Fed expanded QE to unlimited amounts Fed Balance Sheet vs. S&P 500 Fed Cut Rates to 0% Fed not planning To raise rates Through 2023 Shape of the Recovery – Goldilocks “Just Right”
  17. 17. BCA Research – Mar 26, 2021 Financial Times – Feb 23, 2021 Martin Wolf – Biden’s Risky Experiment Mar 6 2020 Coronavirus & Vaccine R&D $8 Billion 0.0% GDP Mar 18 2020 Paid Sick Leave & UI Claims $192 Billion 0.9% GDP Mar 27 2020 Cares Act $1.7 Trillion 7.9% GDP Apr 21 2020 Payroll Protection Plan $483 billion 2.2% GDP Dec 27 2020 Phase 4 $900 Billion 4.2% GDP Mar 11 2021 American Rescue Plan $1.9 Trillion 8.8% GDP Total $3.3 Trillion 24% GDP Proposed American Jobs Plan $2.3 Trillion 10.0% GDP Coming Soon? American Families Plan $1-2 Trillion? 5-10% GDP? Shape of the Recovery – Goldilocks “Just Right”
  18. 18. Shape of the Recovery – Goldilocks “Just Right” WSJ – April 12, 2021
  19. 19. Shape of the Recovery – Goldilocks “Just Right” Strategas – April 21, 2021 May 29, 2020 CHEAP EXPENSIVE 63 bps 180 bps Valuation Bad Predictor Valuation Good Predictor
  20. 20. 10 Treasury Yield Shape of the Recovery – Goldilocks “Just Right” 10 Year US Treasury 10 Year US Treasury 10 Treasury Yield 10 Y Breakeven Rate Danger Zone Pre-pandemic
  21. 21. BMO – Feb 24, 2021 Strategas – Mar 12, 2021 Shape of the Recovery – Goldilocks “Just Right”
  22. 22. 10 Year Started to Rise Earnings Peak Market Peak The Daily Shot – April 13, 2021 Bloomberg Shape of the Recovery – Goldilocks “Just Right” S&P 500 10 Y US Treasury Earnings 15 months +260 bps 10 Year Started to Fall
  23. 23. Shape of the Recovery– Right Tail (Inflation) WSJ – April 26, 2021 Expected Inflation Transitory Inflation?
  24. 24. Shape of the Recovery– Right Tail (Inflation) Bloomberg - April 12, 2021 Base Effect
  25. 25. Financial Times – Jan 14, 2021 Financial Times – Mar 29, 2021 WSJ – Mar 25, 2021 Shape of the Recovery– Right Tail (Inflation)
  26. 26. BMO – Mar 11, 2021 Goldman Sachs – April 6, 2021 Former Treasury Secretary Larry Summers Reintroduced “Secular Stagnation” Least responsible economic policy in 40 years One third chance of significant inflation over next few years Shape of the Recovery– Right Tail (Inflation) $1,400 Checks During the Pandemic Americans +$1.8 trillion extra savings 3 Rounds of stimulus payments = $877 billion Households saved 26%
  27. 27. Financial Times – Mar 22, 2021 “A government that robs Peter to pay Paul can always count on the support of Paul” George Bernard Shaw Pew Research – March 1-7 70% US Adults Favor $1.9 trillion COVID-19 economic aid bill Shape of the Recovery– Right Tail (Inflation) Federal Reserve’s Role Keep interest rates low so Biden can spend Run economy hotter to increase minority participation
  28. 28. Barron’s – April 5, 2021 Value Stocks More earnings sensitive Bernstein – Feb 9, 2021 Benefit More (lose less) as rates rise Benefit More as rates fall Growth Stocks More interest rate sensitive Investment Strategies – Equity Duration Inflation Profit Margin
  29. 29. Strategas – Mar 22, 2021 29.2% 73.4% The Daily Shot – Mar 31, 2021 Investment Strategies – Equity Duration
  30. 30. BCA Research – Feb 25, 2021 Bond Yields Up (Bond Prices Down) Stocks Up Stocks Down Bond Yields Down (Bond Prices Up) Inflation – Low and predictable Correlation Stocks-Bond Yields positive Inflation > 2% Stocks-Bonds Correlation neg Yields Up Stocks Down Stocks go down So do Bonds Investment Strategies – Bond Alternatives Inflation ` Stock Bond Yield Correlation
  31. 31. The Daily Shot – Mar 29, 2021 Investment Strategies – Bond Alternatives Infrastructure Real Estate WSJ – April 22, 2021 WSJ – April 20, 2021
  32. 32. • Goldilocks good for market • Left Tail risk eliminated • “Goldilocks” market is expensive • But manageable if rates stay low • Risk is Right Tail “inflation” risk • Potential for correction • Longer term risks • Need to re-think portfolio construction Summary
  33. 33. 2021 Strategic Outlook John Nicola, Chairman & CEO
  34. 34. Are Happy Days Here Again? Who Prevails Bulls or Bears?
  35. 35. Bubble Bubble Toil and Trouble (1-yr returns Mar 31/21) NYSE 61% Hang Seng 29% London FTSE 32% TSX 50% Euro Stoxx 51%
  36. 36. Dot Com Bubble -48% Great Financial Crisis -54% Covid-19 -32% Index return Jan 2000 - Apr 2021 = 2.67% (5.9% incl dividends $CAD) S&P 500 2000 - 2021
  37. 37. Peak Feb/Mar 2000 - Recovery Oct 2017 Total return Jan 2000 - Apr 2021 = 3.5%/yr. Nasdaq 2000 - 2021
  38. 38. “It is advisable for one that he should divide his money in three parts, one of which he shall invest in real estate, one of which in business, and the third part to remain always in his hands.” – The Talmud NW Core Asset Allocation
  39. 39. -5.7% -10.8% 5.8% 7.5% 45% less volatility
  40. 40. Investing Well: Canada’s Pension Plans
  41. 41. As of November 2020, 96% of large plans (characterized as those with over $5 billion in assets) and 73% of plans overall either held alternatives or intended to add them within the next 12 months Aon’s Erwan Pirou, the chief investment officer of the retirement solutions group, said his company’s clients are interested in diversifying their risk by putting more money into real assets such as real estate and infrastructure, or into other “opportunistic” strategies.
  42. 42. Our Real Estate Platform Nicola Canadian Real Estate LP (2005)  59 Properties of office, retail, industrials, storage, seniors & multi- family use  GAV: $1.53B | NAV: $789M  Return Since Inception 9.1% Nicola US Real Estate LP (2010)  86 Properties of office, retail, industrial & multi-family use  GAV: $2.1B USD | NAV $970M USD  Return Since Inception: 10.8% Nicola Value Add Real Estate LP (2014)  47 Properties in development for office, retail, industrial & residential use  NAV $359M  Return Since Inception: 14.1% Valued at over $5.0B in gross assets ($2.6B client equity)
  43. 43. Half full or Half empty
  44. 44. Will this reduce demand for space
  45. 45. Future Questions • Will North American population increase faster than Europe or Asia? • Will the overall economy be bigger? • What role will technology play in terms of how we learn, work, and buy? • Will certain regions in North America grow faster than overall growth? • What impact will demographics have? • How long will financing rates remain low? • What % of my portfolio should be investment grade real estate? • What are my expectations of total returns in bonds, stocks, and real estate? As of April 2021 Requests for sub-leases are being withdrawn and appraisals in some markets and asset classes are recovering
  46. 46. Returns for Real Estate Pools (Dec 2020) 2.20% 7.20% 9.50% 8.0% 10.9% 14.5% 8.9% 11.2% 0.0% 6.40% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% Canadian Income US Income Value Add 1 year 5year 10 year YTD 2021 97.6% rents collected 2020
  47. 47. NW Private Real Estate vs. Public REITS +17% -80% -80% +27%
  48. 48. Private Equity · Infrastructure · Private Debt · Farmland Extensive Asset Classes
  49. 49. Better risk adjusted returns Greater Risk Greater Return
  50. 50. • $460M of assets • 9-year history • Funds 93% fully invested (smaller cash float impact) • 5-year returns 10.5% (3.2%/yr. more than CDN equity) • Significant increase in direct investments (almost 50% by Q2 2021) • Major directs include MDA, Vendasta, Corfin
  51. 51. Renewable Energy: Not just SRI - Disruptive Technology • SWB could be 100% of US electrical grid by 2030 • This would apply to most other developed countries • Not just cleaner but cheaper. Massively disruptive technology (think Blockbuster and Netflix) • Growth rates will be exponential • Most countries, states, and provinces are fossil fuel dependent
  52. 52. +59% since Sep 2019 -8% YTD Invest using Dollar Cost Averaging
  53. 53. • Created 1997 for our clients • Manages 150+ Donor Advised Funds • $120M of Assets under management • NW pays 100% of all operating, governance and administrative costs • Can accept appreciated public company shares as gifts (Tax savings can be as high as 80%)
  54. 54. 54% of taxes are paid by the top 10% of income earners. 21% of taxes are paid by the Top 1%. If this is not fair, then what is the right number?
  55. 55. • Marginal Tax rates at the highest level • Capital gains inclusion rate • Wealth Tax
  56. 56. Customized approach based on your situation
  57. 57. Will doubling the national debt in both Canada and the US create an insurmountable burden for future generations ?
  58. 58. Federal debt has doubled
  59. 59. US 13th 105% Canada 26th 89% Someone’s debt is someone else’s asset Not repaid Still outstanding
  60. 60. Is this where we want to be number 1?
  61. 61. Debt is rarely reduced This is now here March 2021 If we run deficits 90% of the time how can our debt ratio stay the same or drop?
  62. 62. Welcome to Extravaganation Our Motto: Only a Borrower Be $1,000,000 $20,000 $20,000 $40,000 $1,040,000 GDP Year 1 Real Growth Inflation Growth Total Growth GDP Year 2 Economic Growth $000,000’s $500,000 $30,000 $530,000 Debt Year 1 Deficit Debt Year 2 Debt/ Deficits $000,000’s Debt/GDP=49.5% Growth>Deficit Deficit =6% of debt 3% of GDP Debt/GDP=50%
  63. 63. 40% WWI 20% WWII 30% Debt Crisis 7%
  64. 64. Asset Allocation is the Key Private Assets Add Value Debt will be Rising And so will Taxes Do your planning now and stay truly balanced in your portfolio
  65. 65. This presentation contains the current opinions of the presenter and such opinions are subject to change without notice. This material is distributed for informational purposes only and is not intended to provide legal, accounting, tax or specific investment advice. Please speak to your Nicola Wealth Advisor regarding your unique situation. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. The Nicola Core Composite returns represent the total returns of Cdn. dollar denominated accounts of all fee-paying portfolios with a Nicola Core mandate. The composite includes clients who are both fully discretionary and nondiscretionary. Historical net of fee composite performance returns are calculated using individual realized time-weighted client returns net of fees and is presented before tax. The Nicola Wealth inclusion policy is based on clients’ weights at calendar month end. The composite returns are asset-weighted based upon ending monthly market value. The Nicola Core mandate may change throughout time. Additional information regarding policies for calculating and reporting returns is available upon request. The composite returns presented represent past performance and is not a reliable indicator of future results, which may vary. Comparisons of the historical performance of Nicola Wealth funds or models to the historical performance of indexes, mutual funds or other investment vehicles should only be undertaken with consideration of the differences that exist between the underlying investments that comprise the compared investment vehicles. Indexes may be primarily composed of a single asset type/asset class (i.e. 100% equities or 100% bonds) whereas Nicola Wealth funds may or may not contain a combination of exchange-traded equities, marketable bonds, private investments, other alternative investment classes and exempt products. When making any comparison of historical performance, these differences and their impact on the performance of each comparable should be taken into account. Past performance is not indicative of future results. All investments contain risk and may gain or lose value. Returns are net of fund expenses charged to date. This is not a sales solicitation. This investment is generally intended for tax residents of Canada who are accredited investors. Some residency restrictions may apply. Please read the relevant documentation for additional details and important disclosure information, including terms of redemption and limited liquidity. Please speak to your Nicola Wealth advisor for advice based on your unique circumstances. Nicola Wealth is registered as a Portfolio Manager, Exempt Market Dealer and Investment Fund Manager with the required provincial securities’ commissions. Hypothetical performance results have many inherent limitations, only some of which are described below. No representation is being made that any account will or is likely to produce profits or losses similar to those shown. In fact, there are frequent sharp differences between hypothetical performance results and the actual results subsequently produced by any particular trading approach. 1) Hypothetical performance results are limited in that they are generally prepared with the benefit of hindsight. 2) Hypothetical trading does not involve financial risk and no hypothetical trading record can completely account for the impact of financial risk in actual trading. The ability to withstand losses or adhere to a particular trading program in spite of trading losses are material points which can adversely affect actual trading results. 3) Numerous other limiting factors related to the behavior and performance of markets in general and/or to the implementation of any specific trading approach cannot be fully accounted for in the preparation of hypothetical performance results all of which can adversely affect actual trading results when compared to the hypothetical model. *Morningstar Canadian Neutral Balanced is a proprietary index developed by Morningstar Canada based on the CIFSC Fund categories ( This index includes funds which meet the following criteria: Funds in the Canadian Neutral Balanced category must invest at least 70% of total assets in a combination of equity securities domiciled in Canada and Canadian dollar-denominated fixed income securities and between 40% and 60% of their total assets in equity securities. ^ This is a blended benchmark of 4 indices minus 1% management fee: Citi World Government Bond, FTSE TMX DEX Universe Bond, MSCI World, S&P TSX Composite

Editor's Notes

  • Agenda:
    In November, we looked at the shaped o the recovery in terms of letter: V, L, W, U
    Today we are going to use a normal distribution to describe the recovery
    Looking at three different scenarios for markets
    We will follow this up by looking at some investment strategies for what we consider the most likely scenario
  • So here’s our normal distribution
    Which maps out different probabilities for economic growth
    We are going to work form left to right
    The far left tail is an environment where the economy is too cold
    Most likely because of a Covid resurgance
    Earnings are falling, and deflation becomes a concern
    This is not a good environment for the market
    In the middle, the most likely scenario, and where we believe we are today
    Growth is strong, but not too strong
    Financial conditions are accommodative and fiscal policy is stimulative
    A very good environment for markets
    Far right tail – Growth becomes too hot
    Inflation starts to pick up
    Interest rates rise
    Like the left tail, the right tail eventually becomes unfavorable for market returns
    BCA Research calls this Goldilocks and the two tails
    We started last March at the left tail
    But Markets have moved away from pricing in the left tail
    Question becomes how close are we in moving towards the right tail
    We think we are here, but moving here
    Let look at each section in more detail
  • Starting with the left tail with the pandemic, vaccines are really the story
    The success of the vaccines has enabled the markets to largely discount the left tail.
    While the US stumbled in dealing with the pandemic last year, and got off to a slow start in rolling out the vaccines, it has made up for lost ground
    Here we see the ramp in daily vaccinations – over 3 million per day
    Biden promised 100 million doses in 100 days, he did over 200 million
    Fallen off a bit, but because finding it harder to find people who haven’t got it
    And on the right we from bloomberg, the US is on track to have 700 million does available by the end of July
    Enough for 400 million
    According to the NYT
    25% fully vaccinated
    65% of 65+ yrs
    40% of adult at least one jab
    By June 8, 70% of the entire US population could get at least one jab
    Even with 40% we are seeing falling new cases, and more importantly hospitalization rates
  • Word of caution here, however
    While infection rates are down, they are still relatively high
    And some regions, like Michigan show in this financial times chart, is spiking higher
    Globally, things are even worse
    We all know what is happening in Canada
    And countries like India are seeing major outbreaks
    A recent Bloomberg article believes we could actually see more deaths this year than last
    The vaccines provide a light at the end of the tunnel
    But it’s not over.
  • In terms of the vaccines it comes down to three main questions
    Will they work against the variants
    Here we list all the variants
    Of all the variants, perhaps the South African is of most concern
    And now the variant found in India – the so called double mutatation
    But generally most are optimistic
    Watching countries like Israel, some breakthrough infections
    Will we take it?
    Astra Zenica and JNJ has hurt confidence, but generally acceptance is trending higher
    This chart from Deutsche Bank, a material increase just from December to January in who would take the vaccine
    When will we get it?
    Most of the developed World this year
    Lump Canada in with Europe
    Developing World is the problem
    Could take years?
    Can we get back to normal?
  • While COVID-19 is still a global health crisis, as far as the market is concerned, it’s moved on
    A BofA April investor survey indicated the top two tail risk events the market was concerned with were a bond market tantrum and inflation,
    These are right tail events, issues we are going to spend some time discussing in a minute
    Covid and the vaccine is all the way down in fourth place, and removing it as a tail risk leads us to our goldilocks scenario when growth is strong, but not too strong
  • This is evident in this next slide
    The economy looks to have made a V shaped recovery with much of the economy re-opened but not all of it
    Here we see restaurant seating nearing pre-pandemic levels
    And even air travel making a strong recovery
    In March, retail spending increased 9.8%
    But, there are still parts of the economy that are fairly weak
    Movie theater ticket sales remain very low
    And urban public transit remains very low, with many still working from home
    Still more 8 million fewer jobs than before the pandemic
    And we don’t know when we will get back to pre pandemic levels
    Remember, we still have some covid concerns

    But yet the market is moving up in a straight line , nearly 80% from it’s Mar 23rd lows
    Recouping all it’s loses, plus another 25%.
    There appears to be a bit of a disconnect between the economy and the economy and the potential speed of the recovery and the market

  • But yet the market appears to be discounting more than this optimistic, but still work in progress recovery in the economy
    After falling 34% to the Mar 23 lows, the S&P 500 has more than recouped all it’s looses, and gained back over 90%
    Same for the S%P/TSX, which fell a little more and gained back a little less, but still pretty spectacular returns
    If not the economy, what is causing markets to move so strongly?
  • The key has been both monetary and fiscal stimulus
    Of record proportions and implemented in record speed
    It doesn’t matter how long it will take
    Fiscal and monetary policy will do whatever it takes
  • For monetary
    As we can see on the chart on the left, the Federal Reserve quickly cut over night interest rates to zero
    And as can bee seen with red dot plot, where each dot represents where a Fed member believes over night rates will be in the future, most don’t see rates rising at least through 2023
    On the right we can see the federal reserve has also influenced longer term yields and liquidity by using its balance sheet to buy bonds and securities
    In fact the announcement of unlimited QE on March 23 low coincided with the market low was probably the single most important event to turn the what market around
    Presently the Fed is buying $80 billion in Treasury’s and $40 billion in mortgages a month, and will first need to start tapering these purchases before even thinking about raising rates
    This is a lot of liquidity the Fed is injecting into the market.
    When the Fed buys securities, the seller needs to deploy the proceeds into another security, thus bidding up the prices of financial assets and this keeping yields low
  • Fiscal policy has been no less extraordinary
    Including what President Biden has done since taking office
    This picture is from an article written by the Financial Time’s Martin Wolf in which he is calling President Biden spending plans, a risk experiment
    We can see this from the chart from BCA
    What noteworthy Is not only how much more is being spent compared to the 2009 financial crisis
    Which was deemed a mistake with not enough fiscal stimulus being deployed
    But how much more the US has spent compared to other countries, and they are done yet.
    If we list all the different programs
    We get $3.3 trillion or 24% of GDP
    Infrastructure could add another $2.25 trillion or 10% of GDP
    And a further bill to address social issues is said to be $1-2 trillion more
    5-10% GDP
    Canada actually stacks up pretty good on this chart
    In fact add 4% to Canada’s for the $100 million announced at last weeks budget
    But the US still has a BIG lead
    Keep in mind, this is happening despite an economy that appears to be on it way to full recovery
  • One of the biggest concerns as we potentially move towards the right tail is the recovery and fiscal stimulus is already priced into the market, and a market bubble is forming
    This chart showing the CAPE Shiller relative10 year inflation adjusted price earnings levels versus its historical average, valuations are not as high as the pre-dotcom bubble levels, but they are still nearly 90% above normal levels.
    The concern is they will eventually need to mean revert, meaning higher valuations today mean lower returns in the future
    We can see this in the scatter chart on the right showing the current valuations along the bottom, versus subsequent 10 year cumulative return
    If we try and add a best fit regression line it would go some where around here
    and adding today’s valuation translates to very mediocre 10 year returns
    Less than 5% per year
    Interestingly in Barron’s this weekend, their Big Money Investors poll of institutional money managers found over 60% thought US equity returns over the next 10 years would be between 5 -10%
  • Valuations can’t be looked at in isolation, however
    On the left if we take the reciprocal of PE multiple and create an earnings yield and subtract the 10 year yield, we can chart the earnings yields over time in excess of the 10 year yields
    The historical average over the past 70 years has been about 60 bps
    An excess yields above this would indicate the market is relatively cheap
    While an excess yield below indicated the market is expensive
    At 180 basis points currently the excess earnings yields is actually higher than average, due to the fact yields are so low
    Equity valuations are expensive, bond valuations yields are even more expensive, and provide a support for valuations.
    Even if we discount the impact of low interest rates, valuations are not good at predicting market returns in the short term
    On the right we see the correlation or R squared of the PE and subsequent returns and we see that valuation id a good predictor of returns in the longer term, but not in the short term
    In the short term, expensive markets can still get more expensive
    And this market has the potential to do just that
  • A risk, however, is that if we justify the valuation on low interest rates, what happens if rates go up?
    This is an important point for the market because bond yields have been rising and there is some concern this could provide a catalyst for a market correction
    Here we show a chart of the 10 year nominal US Treasury Yield in white, which after bottom in august of last year at around 0.5%, has started to move higher, topping 1.7% in late March
    Where is the danger zone for the market?
    According to an investor poll conducted by Strategas some believe 2.5%, which still leave the market with room to move upwards 2.5-1.6=90bps
    This is a moving target, however, and the speed of the ascent is perhaps more important than the actual level.
    Keep in mind, not even at pre-pandemic levels
    Now inflationary expectations have moved above pre-pandemic levals, but as can seen on the next slide, we don’t think either yileds or inflationary epxecations are an issue at these levels.
  • Higher rates and higher inflation are not bad for the economy in themselves
    They can be expected, and in fact welcomed as the economy strengthens, and should be good for stocks.
    This is especially the case when the starting point for rates are very low
    We can see this on the left we see a bar chart from BMO showing returns for stocks are highest when the YTD increase in 10 Y yields range from 50-100 bps.
    Year over year, we are around 100 bps now
    And on the right, we see from Strategas inflation of 0-2% has historically been associated with the highest market valuations, but 2-4% is the next highest tranche.
    Higher inflation starts to become more problematic, when it compels central banks to start tightening monetary policy and raising rates
    This driving real rates higher
    And eventually hurting earnings growth
  • We can see a real world example of this by looking at the dot com bubble of the last 1990’s
    Most believe higher rates were what finally bust the dot com bubble, but when we take a closer look, we see that is not quite true
    As we can see here, yields started to rise in 1998, but the market kept rising
    Over the course of 15 months in fact, rates increased 260 bps to nearly 7%
    In fact by the time the market peaked in 2000, yields had actually already started to decline
    Rather than interest rates, it was earnings that peaked in line with the markets and signaled the end of the bull market, not interest rates.
    Of course higher interest rates may have helped reduce earnings by slowing the economy, but there was a material lag
    On the right we show current earing estimates, which are showing no signs of weakness
    According to Strategas, 2022 earnings could be up 14%
    Though tax increase could take 5-8% off this

  • So higher interest rates and increased inflationary expectations don’t signal an end to the bull market
    But it is a signal we are moving towards the right tail, which if we continue on this path, will lead to tighter financial conditions which will end the bull market
    So are we? How close are we to inflation and tighter monetary conditions?
    As we can see on the left, this is the massive consensus according to a BofA survey of fund managers
    Above trend growth and above trend inflation is not only a tail risk, it is now the most likely scenario
    And why not – A reopening economy, low interest rates, and record fiscal spending
    But how sustainable or transitory?
    This is the key debate for investors
    As we can see on the right inflationary expectation are expected to move higher, but then drift back towards 2%
    This means financial market are expecting higher inflation in the short term, but for it to come back towards the 2% level over the next 5 years.
    For the time being
  • We are pretty confident we are going to see a material increase in inflation in the short term
    If just because of what its called the base effect
    In this Bloomberg graph we also see how low inflation got last year during the pandemic
    Just the year over year comparison off those low numbers is going to lead to much higher inflation
  • And then there is the supply chain
    We can already see pressure building in the supply chain like a pressure cooker
    From the impact from the pandemic, to weather events, to the recent blockage in the suez canal
    On the left manufactures in the US are seeing inflationary pressures
    While on the right a WSJ article in late March highlighted how supply side pressures globally are pressuring factories globally with higher input prices and lengthening delivery times
    The question remains
    How much of these increases will they be able to pass on to you, the consumer.
  • Probably more that you would like, because the consumer is pretty flush right now, and likely in a buying mood.
    On the left we can see at the beginning of the pandemic, personal income plummeted, but was also immediately replaced by income replacement from the government. In fact it was more than replaced.
    During the pandemic it is estimated Americans accumulated $1.8 trillion in excess savings
    Partially because they were locked down and couldn’t spend their money
    And partially due to three rounds of stimulus payments where they received $877 billion and saved 26% of it
    With the last $1.9 trillion package, anyone making under $70k got $1,400. Even if they didn’t lose any income.
    Surely this is inflationary, right?
    Well, no not if the economy is operating below capacity, meaning there is an output gap
    Problem with this can be see on the right with this chart from Goldman Sachs
    Not only does GS see the output gap being eliminated by the stimulus, but they believe the stimulus is 6 times the size of the current output gap
    According to former Treasury Secretary Lawrence Summers, this latest program is the least responsible economic policy in 40 years
    This is significant because not only is Summers a Democrat
    But he is also best known as warning against the perils of secular stagnation and how more fiscal spending is needed to get out of the secular stagnation rut.
    Summers puts a one third probability of significant inflation and inflationary exectations get de-anchored
  • Part of why we believe he is right Biden appears to view the current situation as an opportunity to reduce inequality and help boost the quality of life for the lower and middle class
    By using targeted fiscal policy
    And he is likely going to have the support to do it
    According to Pew Research, 70% of Americans favored Bidens $1.9 trillion Aid bill
    According to George Bernard Shaw, “a government that robs Peter to pay Paul, can always count on Paul’s support”
    The Fed will also have a role to play in reducing inequality – in two ways
    First – by helping facilitate the government spending and higher debt levels by keeping interest rates low
    And second by letting the economy run hotter in order to get more people back into the labor force
    Rather than just looking at headline unemployment, rather they will try and get unemployment low enough that it increases the participation rates and gets minorities back into the labor force
    The Fed’s resolve is likely to be tested, however
    They say they are not even thinking about thinking about raising rates
    But if inflation really spike higher
    And bond yields move upwards with the yield curve steepening
    Will they stay the course in order to drive unemployment lower?
  • What bond yields do is particularly important for investment portfolios and the market.
    We have already seen how it can impact stocks valuations
    Lower rates have enabled valuations to move higher
    But as we look under the hood more closely
    We see not all stocks are created when it comes to how they react to lower interest rates, and now maybe higher rates
    As we can se in this chart from Bernstein, the value of a company is the discounted present value of it’s future cashflow or earnings, including the terminal value
    With growth stocks, the terminal value is more important, which is further out into the future, which makes it more interest rates sensitive
    Some tech stocks don’t have nay earnings, so its all terminal value
    With value stocks or cyclicals, the shorter term earnings contribute more to the value of the company, so it is less sensitive to interest rates, but more sensitive to the economy and other near term events that could impact those cashflows.
    As interest rates start moving up, this will weigh more on the longer duration growth stocks to the benefit of the value and cyclical companies, who should also benefit from a strong economy and stronger earnings.
    One thing to point out with the value/cyclicals, however, is if rates are going up because of inflation, they have to be able to pass on the price increase or their margins will go down.
    Higher interest rates and inflation again don’t treat all companies equally
    Higher quality companies with good balance sheets and pricing power should be the focus
  • As we can see in the chart on the left, sectors that tend to be able to pass on price increases and are good inflation hedges include
    Energy and material are the best.
    Financials also benefit from a steeper yields curve and higher interest rates, as well as loan growth from a stronger economy
    While Industrial and real estate should benefit from a stronger economic growth and the ability to hopefully pass through price increases
    Same with technology, however the discount rate on their cashflows and higher starting valuations provide an offset
    On the right, when we look at global markets, the US is considered a growth market where as many other global markets have a greater value or cyclical exposure
    Canada in particular is a standout
    Cyclical sectors like Energy, Industrial, Financial, and materials, comprise nearly 73% of Canadian stocks the TSX
    Versus just under 27% for the US
    Canadian stocks are better positioned for a more inflationary environment
    They are cheaper
    And being strategically close to the US, Canada will benefit from a stronger US economy
    Doesn’t mean can’t own US Stock
    Very deep market – can get any factor risk, cap size , sector you want
    Buy avoid the index
  • Higher inflation and higher interest rates also has broader implications for asset allocators.
    As can be seen in this BCA chart
    On the top we have stock/bond yield correlation, and the bottom line is inflation
    Over the past 20 years while inflation has been low and predicable: stock and bond yields have been positively correlated
    When stocks were moving higher, bond yields were as well, with bond prices going down.
    Stocks go up with stronger economic growth, which also meant interest rates would typically be rising
    And investors would be selling bonds to buy stocks
    More importantly, when stocks were going down, bond yields fell and bond prices increased as central banks cuts rates and investors shifted out of stocks to the safety of bonds
    Importantly higher bond values provided investors in a diversified portfolio a buffer and diversification when stocks fell
    Effectively investors could take more risk in holding equities, if they also held bonds to offset some of the risk. Rule of thumb, 60% Stocks/40 % bonds
    This relationship between stocks and bond yields hasn’t always been positive, however
    From roughly 1966 to 1997 it was negative – Falling stocks were associated with rising yields
    Not coincidently this was during a period when inflation was greater than 2%
    If we are coming back to this environment, need bond alternative
    Doesn’t mean no Bonds – just don’t hold to offset equity risk
  • On the left we seen what asset classes did well during the inflationary 1970’s, and thus could be good portfolio diversifiers
    Commodities, gold top the list, though with gold we would stress this will only be the case if inflation increases more than nominal rates and real interest rates stay low
    Yes value stocks, but in most 60/40 portfolios, you already have enough stocks
    Need a alternative to bonds
    Infrastructure but also real estate have similar abilities to protect against inflation.
    As long as leases are short enough, you are able to keep our building leased, and you leverage is reasonable and matched to leases terms, real estate is a real asset
    And can be a bond alterative
    What doesn’t work?
    High duration asset valued entire on their terminal value, which itself is questionable
    Take cryptocurrency Dogecoin, which has been referred to as a a bubble within a bubble
    This crypto currency was created as a joke in 2013
    Reached a value of $50 billion recently, more than Ford and Kraft Heinz
    Perhaps even worse, however, is using Leverage used to buy over valued growth stocks.
    Bill Hwang family Office Archegos lost $20 billion in 2 days being 5 times levered in a concentrated portfolio of growth stocks
  • So in summary
    When we look at the normal distribution, we still believe we are in the goldilocks middle, not too hot or not too cold.
    We still worry about the pandemic and how it will play out but unless there is a material problem with the vaccines, we don’t think it will trouble the market and the left tail risk has largely been eliminated
    Recovering economy, easy monetary policy and record fiscal stimulus
    This is a very good environment for the market
    We do, however think we are moving closer to the right “hot” tail, however
    The economy is recovering faster than expected but more stimulus is being applied
    A spike in the short term is in the cards and could lead to a correction
    But continued government intervention and the desire to address inequality could lead to higher sustained inflation
    But that doesn’t mean it should be ignore, and investors need to start thinking about how to navigate a world with higher inflation, as will central bonds.