January 2021

Dear CIBC Wood Gundy Client:

Since my last update (September 2020), a lot has happened to say the least. Most notably, we have a new President of the United States on January 20th (but not without a minor insurrection in the Capital Building in Washington), we now have three COVID-19 vaccines approved and being distributed globally, and more in the works. As we end the first three weeks of trading for 2021, we are witnessing a market that seems determined to advance higher, shrugging off concerns about political unrest, economic weakness, high unemployment and high levels of global debt as central banks around the world print money to support their economies. In fact, we ended 2020 near record highs for the major market indexes, with the Canadian TSX index finishing the year up 5.6% including dividends, and the US S&P500 index up 16.1%.

At first glance, this appears to make no sense, as one could reasonably assume that with a global pandemic in full swing, we should also expect world economies to be in disarray and stock markets moving lower. So has the market lost touch with reality or is there some rational explanation for this unexpected turn of events?

There are several factors that explain why we have seen such resilient markets in 2020. Firstly, and most importantly, we have had the Bank of Canada, the Federal Reserve and most every other central bank in the developed world lowering interest rates and injecting capital into the financial markets in order to support their economies. This means people and businesses can borrow money at exceptionally low interest rates and money is available to keep the world’s economies functioning normally. This action also inflates the value of financial assets like stocks. Secondly, we are in the midst of a major growth cycle for technology businesses which are transforming how we live and work. This includes sectors such as 5G, cybersecurity, digitation, e-commerce, remote work, semi-conductors, electrification of cars, and alternative energy, to name just a few. Thirdly, the market is anticipating a major stimulus package this year from the Biden administration which will support struggling businesses and individuals who have lost their jobs. This money will drive increases in consumer spending, new infrastructure and create new jobs, all of which is positive for the U.S. economy. When the U.S. economy is doing well, Canada also benefits. Fourthly, the new Democratic administration in the U.S. will likely mean a return to more global cooperation and better relations with China and the U.S.. This will have positive benefits for Canadian companies who export products to China and for U.S. companies looking to expand trade with China. Fifthly, the market is looking beyond the current COVID-19 pandemic with all its negatives, to the recovery on the other side, once a vaccine is widely distributed. The market therefore sees the pandemic as a transient issue after which the economy will return to normal. Sixthly, we have seen an incredibly rapid vaccine development effort by pharmaceutical companies around the world. Pfizer, Astrazeneca and Moderna now have their vaccines approved and being circulated in countries around the world including Canada (only Pfizer and Moderna vaccines are approved by Canadian Healthcare regulators). Additional new therapies and vaccines will be mostly likely come to market in the coming months. All this gives investors confidence that the end of the COVID-19 virus is coming, although no one can predict with certainty when this will happen.

So what can we expect in 2021 and will these trends continue to propel the markets higher? The short answer is most likely, yes. Economists and forecasters are expecting a sharp recovery in corporate earnings in 2021 as consumers and businesses return to their normal activities post-COVID-19. Many estimates forecast a 20% to 30% increase in U.S. corporate earnings this year, which will help support market multiples. Expectations are also that interest rates will remain low for the next year or two at least, and central banks have repeatedly said they have no expectations for the need to raise interest rates any time soon. Inflation remains contained and this all supports historically high market valuations. Investors looking for income in retirement and for sources of growth for their savings will not be able to find much help from the bond market where yields are near zero and in some cases, negative after factoring in inflation. This means the stock market is the only place for investors seeking real returns on their investments.

So what could go wrong and upset this seemingly rosy outlook? The number one issue would be rising inflation. This would force accommodative central banks around the world to raise interest rates, which would deflate stock valuations. Currently, there are no signs of significant inflation, although we have seen U.S. 10-year Treasury yields back up to over 1% as the U.S. economy shows signs of renewed growth. But it would take much more than this to convince markets that inflation is becoming a problem. Jay Powell, the Federal Reserve Chair, has said he is willing to accept higher inflation for some period of time before he would need to act and raise rates. In fact, he has said he sees no need to raise interest rates for some time, perhaps several years.

That said, there are some areas for concern with respect to high valuations in the tech sector which are beginning to raise concerns. Names like Door-Dash, Tesla and the large number of new SPAC IPOs coming to market have some concerned about a tech bubble. To be sure, cycles come and go and no market uptrend can continue forever without an occasional pullback. Most years while in the midst of a bull market, we can expect to see at least one 10% pullback and this year will be no exception. But this does not mean the market will not recover and continue higher as we move through 2021, as I expect it will, setting new all-time highs for the major markets.

There likely will continue to be good progress from the growth areas that dominated 2020, but returns will be more subdued. Elsewhere we can expect better performance from the cyclical stocks such as financials, transportation, industrials and even energy names. The recovery trade will also benefit the consumer discretionary names such as travel and leisure, although this will be halting, uneven and will depend on the efficient rollout of the COVID-19 vaccine and a willingness on the part of people to take it. Bonds will continue to offer little or no returns in 2021, with their valuations at multi-decade all-time highs, and therefore, should be mostly avoided.

A return to pre-COVID-19 normalcy may take longer than we would hope, and will depend on efficacy of the various vaccines and therapies still being developed and perfected. We could see additional peaks of virus outbreaks in the future, setting back the pace of economic rebound. This would favor the stay-at-home stocks that dominated markets in 2020. Also, the continuing technological advancements in 5G, digitization, green energy, e-commerce and artificial intelligence will continue to offer some of the best longer-term performance, albeit with greater potential for volatility as valuations rise.

Geographically, the U.S. markets are valued richly at this time, and in some ways for well justified reasons. However, growth will likely persist in the U.S. again in 2021. Alternatives in Asia and emerging markets offer better value and the potential for a recovery of the 2020 lows as the world’s economies recover.

A sense of cautious optimism would best describe the consensus for the year ahead, a view I very much share. As we move into a new year, investors should use this opportunity to review their strategy for the coming year and ensure they are aligned with the best opportunities for growth and income in the year ahead. Please call me and we can discuss your specific goals and risk tolerance and ensure you are properly allocated to achieve your goals for 2021.

Sincerely,

CIBC Wood Gundy

Gordon A. Forsey, P. Eng., MBA, CIM, FSCI

Portfolio Manager, Investment Advisor

Gordon Forsey Advisory Group

 

This information, including any opinion, is based on various sources believed to be reliable, but its accuracy cannot be guaranteed and is subject to change. CIBC and CIBC World Markets Inc., their affiliates, directors, officers and employees may buy, sell, or hold a position in securities of a company mentioned herein, its affiliates or subsidiaries, and may also perform financial advisory with the same. CIBC World Markets Inc. and its representatives will receive sales commissions and/or a spread between bid and ask prices services, investment banking or other services for, or have lending or other credit relationships if you purchase, sell or hold the securities referred to above. © CIBC World Markets Inc. 2021.

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The comments and opinions expressed herein are the result of work done by Gord Forsey. They may differ from the opinions of CIBC World Markets Research Department and should not be considered representative of CIBC World Markets Inc.'s beliefs, opinions or recommendations. This information, including any opinion, is based on various sources believed to be reliable, but its accuracy cannot be guaranteed. It is for information only, and is subject to change at any time.