INVESTMENT COMMENTARY - JULY 2021 - CWBMP.COM - CWB MCLEAN & PARTNERS
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Investment Commentary July 2021 CWBMP.COM OBSESSED WITH YOUR SUCCESS ™
Inside Heat wave signals a hot economy......... 2 Canada............................................3-4 U.S...................................................5-6 International........................................7 Fixed Income...................................8-9
Heat wave signals a hot economy
Scott Blair, CFA
Chief Investment Officer
The end of June saw record-breaking temperatures across western Weaning off support programs
Canada. According to the CBC, the village of Lytton, BC broke a Early on in the pandemic, we were encouraged by the size and
new record high for temperature in Canada at 47.9°C on June 28. speed of the economic stimulus introduced by world governments
The CBC also noted that this is hotter than the highest temperature and central banks, but we worried about the handoff from stimulus
ever recorded in Las Vegas, and about eight degrees above Lytton’s to the real economy. As many COVID-19-related support programs
previous high prior to this year. Only about one-third of homes across roll off in Canada over the next several months, we see many
Alberta and BC have air-conditioning (just over 60% of Canadians indicators that our economy is ready for it:
have air conditioners), causing a short-term move back to the office
for some workers to escape the heat. • Job vacancies are up almost 8% in Q1/21 vs Q1/20. This is the
most recent data available from Stats Canada. More current data
The hot economy in the U.S. and business surveys supports the idea that there is no
The heatwave is somewhat of a precursor to what’s shaping up shortage of employment opportunities. Expect more job openings
to be a scorcher of a summer from an economic standpoint. as the summer progresses.
Many economists believe that the Canadian economy will grow
• Excess savings are through the roof, with the savings rate in
at an almost 10% rate in Q3 vs Q2. It’s a truly staggering number
Canada coming in above 10% for five quarters in a row. By way of
that reflects a significant easing of COVID-19 restrictions. Some
comparison, our savings rate is usually in the low single digits.
provinces are moving quickly. For instance, Alberta’s Open for
• Disposable income has recovered. According to National Bank
Summer Plan took effect on July 1, with virtually all restrictions
Financial, our disposable income levels are now back to pre
lifted. Other provinces, like Ontario, are moving forward at a more
COVID-19 trend levels, even without factoring in COVID-19
measured pace, but the key here is forward momentum.
support programs.
The pace with which Canadians have stepped up to get vaccinated
is nothing short of remarkable. As of the end of June, over 67% of
Virus vigilance
Canadians had received at least one dose of the vaccine, ranking us Although the short-term looks very positive, there are always clouds
among the world leaders. However, we still lag somewhat on fully on the horizon to keep in our sights. The biggest one continues to
vaccinated individuals with only around 30% of Canadians falling in be the virus and, more precisely, new variants. The delta variant that
that category, but we’re quickly catching up (Figure 1). has caused so much pain in India, is more transmissible and deadlier
than earlier variants. It’s already causing reopening plans in the UK
Should this momentum continue, we can expect more restrictions to be paused and it is rapidly becoming the dominant strain in North
to be lifted such as in-class learning, a return-to-office workday in America. Some positive news about the variant from the spread in
some form, and the full reopening of the border. These will all serve the UK is that fully vaccinated people are well protected; this should
as economic catalysts. Whether you’re a fan of the Prime Minister provide more urgency to get our second shots in order to avoid
or not, it’s easy to see why he appears to be leaning towards a any restrictions.
summer election.
Despite potential headwinds, overall, the summer of 2021 is
Figure 1: COVID-19 vaccination campaign (as of July 2) shaping up to be a big improvement over summer 2020. Summer
months tend to be quieter for the equity markets, which have had
Share of people fully vaccinated Share of people only partly vaccinated
a spectacular run so far this year. A breather would not be a huge
Canada 31.0 37.2 surprise, since volumes tend to dry up while participants reassess
UK 48.7 17.4 in the fall.
Israel 59.8 5.1 As we continue on our journey to get back to normal, one activity
you may want to consider is purchasing apparel. Clothing sales
Germany 37.0 17.7
were still down over 30% from pre-pandemic levels in Canada.
U.S. 46.6 7.6 If we return to office workspaces (even partially) or to in-class
France 31.2 19.1 learning, clothing could replace air conditioners as the next item
in short supply at the mall – although the run on sweatpants
Japan 12.7 11.3
is likely over.
India 4.3 15.7
0 10 20 30 40 50 60 70
Source: Desjardins Capital Markets and Economic Studies
2
Canada
WATCHING
The Canadian equity markets continue to be rewarding investors Gil Lamothe, CFA
through the second quarter of 2021. The S&P/TSX index was up Senior Portfolio Manager, Canadian Equities
8.5%. This compares favorably to global markets, including the
U.S. We often see this when commodity prices are strengthening,
as has been the case with base metals, oil, and fertilizers, among
others. International investors still see Canada as a resource-based
The energy sector has been a strong performer. We reported
economy. As they allocate capital towards our markets, we see
last quarter that Brookfield Infrastructure’s bid to purchase Inter
the benefit in terms of higher equity values. Another noticeable
Pipelines (IPL) suggested that there was value in the pipeline sector.
effect of this movement of capital towards Canada has been in the
Though the oil producers have been the stronger performers
strength of our dollar. To buy Canadian assets, you need Canadian
year-to-date, the pipeline stocks have done very well this quarter
dollars, and the demand for them has been a steady tailwind for the
also. Furthermore, Pembina Pipelines (PPL) has also placed a bid,
currency during most of 2021 (Figure 2).
supported by IPL management, to purchase IPL. Brookfield has
In actual fact, much of this capital flows towards our banking stocks, since sweetened its bid in order to woo shareholder support.
as proxies for our economy. It just so happens that our banks have
Another acquisition drama is unfolding within the transportation
been deserving of these flows, as they’ve continued to report
sector, more specifically, the railways. In late March, CP Rail (CP)
excellent results this quarter as well. The capital ratios they exhibit
made a bid to purchase Kansas City Southern Railroad (KSU), an
are very strong which, in our view, makes them among the best
American railway that operates into Mexico. By the end of April,
banks in the world. We continue to wait patiently for the Office of
CN Rail (CNR) came out a significantly higher bid for KSU. CP Rail,
the Superintendent of Financial Institutions (OSFI), the regulator
perhaps wisely, decided that it would not try to outbid CNR and risk
overseeing the banks and life-cos, to remove its pandemic-related
overleveraging its balance sheet. Whether or not CNR is successful
dividend growth restrictions and to once again allow the Canadian
with its bid is now in the hands of the Surface Transportation Board,
banks to continue growing their dividends.
the regulating body in the United States.
3 | INVESTMENT COMMENTARY
Figure 2: S&P/TSX vs. Bank of Canada Commodity Avg. Price Index
S&P/TSX Index (L) BoC Commodity Avg. Price Index (R)
20,500 730
710
20,000
690
19,500
670
19,000 650
18,500 630
610
18,000
590
17,500
570
17,000 550
Dec 2020 Jan 2021 Feb 2021 Mar 2021 Apr 2021 May 2021 Jun 2021
Source: Bloomberg
THINKING
We’re hopeful that Pembina Pipelines will succeed in their bid for The company has a very measured approach to mine expansion,
IPL. The company outlined a very cohesive plan for the merger. with a solid pipeline of options in this regard going forward. The
The synergies and resulting efficiencies suggest that the combined geographic concentration within Canada, with smaller mines in
businesses would result in a more valuable single company. Mexico and Finland, minimize the political risk with which many
other mining companies are faced.
On the other hand, we’re somewhat less excited regarding the CN
Rail bid for Kansas City Southern. CNR is paying a premium for Within the energy sector, we’ve increased our holdings in both
KSU, as well as a break fee embedded in CP’s original deal with Suncor (SU) and Canadian Natural Resources (CNQ), as well as
KSU ($700 million). This will impact the quality of CNR’s balance having added TC Energy (TRP). The energy sector continues to
sheet for several years. There’s also a large amount of regulatory rebound from what was a particularly harsh cycle bottom in the
risk involving whether, and in what form a merger might be allowed. opening months of the COVID-19 related shutdowns, just over a
CN Rail has previously argued to the STB that the existence of year ago. As the world begins reopening, the energy sector should
KSU provided ample competition to them, when advocating their enjoy a steady tailwind of demand. It’s worth noting that the WTI
purchase of the Illinois Central Railway. It’s difficult to now see how oil price has increased from $60/barrel at the beginning of April
the regulator can ignore that argument, when considering whether to $73 more recently.
to allow CNR to remove that competitor. There’s still much to unfold
Sticking with the commodity theme, fertilizer prices have been
in this story, and we’ll continue evaluating things as they evolve.
consistently stronger through the quarter. We’ve added to our
position in Nutrien (NTR). The company will produce an additional
1 million tonnes of potash this year, bringing the total for the year
DOING to upwards of 13.5 million tonnes, a record for the company.
We’ve been relatively busy in the portfolio during the second We’re cautiously optimistic that this strength will continue into
quarter. The addition of Agnico Eagle Mines (AEM) gives us some year end, though fertilizer markets can be quite volatile.
exposure to gold. With recent concerns regarding increased
inflation in the coming months, we think it’s prudent to have some
exposure here. For many years prior to the onset of the COVID-19
pandemic, gold and gold stocks weren’t seen by the market as the
safe havens they once were. That’s changed somewhat through
the past year. In our view, Agnico is a best-of-breed gold miner.
4
U.S.
WATCHING
“Expect the unexpected” seems an appropriate adage for U.S.
Liliana Tzvetkova, CFA
market performance in Q2. The whole world has been talking
Portfolio Manager, U.S. Equities
about recovery, cyclicals, inflation and the need for central
banks to pull back their “easy money” policies sooner rather than
later. One would expect value stocks to continue to outperform
in such an environment. Yet, bond yields fell (U.S. 10 year fell
~30bps (0.30%)) and growth stocks outperformed value stocks
rising 11.7% versus 4.5% for the latter group during the quarter.
Who would have thought that REITS and technology would be Saket Mundra, CFA, MBA
the best performing sectors in Q2 when at the end of Q1 it was Portfolio Manager, U.S. Equities
all about banks, industrials and materials?
The tug of war between market participants continues with
the ongoing debate on whether inflation is a long-term issue,
or whether it’s just transitory. Reopening and recovery has With over 50% of U.S. adults at least partly vaccinated and
helped certain sectors and businesses, such as banks and many states already re-opened, it’s a fair question to ask if the
car companies, over the past 9-12 months. Ultimately, this led demand can continue at these unprecedented levels supported
to outsized earnings growth from trough levels last year and by new sectors such as restaurants and travelling while the
analysts have been forced to revise earnings higher, driving work-from-home beneficiaries recede to normal levels. If
stellar equity market performance. However, during the past this isn’t a hard enough question to answer, the market is
month investors have started to think about peak levels of further looking at the impact of more stimulus through a large
growth and demand, which ultimately affects earnings growth U.S. infrastructure deal, debt ceiling and the hand-off from
and revisions. government to private sector in the coming months. And finally,
the virus remains a wildcard with newer variants especially in
some of the less vaccinated parts of the world.
5 | INVESTMENT COMMENTARY
THINKING
While all these questions are extremely important, we’re keeping While we agree that macro variables and policy actions play an
our eye on the ball with a focus on investing in quality business increasingly important role in the markets, we’re also aware that
when the risk-reward is favorable. It’s easy to get lost in the debates they’re inherently complex to predict on a consistent basis. Hence,
of growth versus value or inflation versus disinflation – losing we strive to strike a balance by investing in businesses that we
the forest for the trees. To us, the more important question is if expect to navigate and thrive under various economic environments.
the industry or the business that we’re invested in can re-invest
and grow its earnings and returns sustainably, using appropriate
leverage. Cycles and downturns come and go – they’re a part of life
– but it’s the underlying businesses that survive over a long period
of time that ultimately reward patient investors and owners.
DOING
During the quarter, the U.S. portfolio performed well despite
the rotation back to growth. While we’re aware of the quarterly
numbers, we don’t give much importance to short-term numbers
and instead focus on executing our investment process to enhance
the portfolio for the long run. Both companies have mid-high single digit
growth opportunities, generate high returns
We exited two of our positions wherein our thesis either played out
on capital and have appropriate balance
or had less probability of materializing. These were eBay and Merck.
sheet with valuations that we deem to be lucrative. We also added
We initiated positions in two new securities, Moody’s and Home
capital to existing names such as AutoZone, Booking, Visa, Gentex,
Depot, both of which met our quality and value thresholds. Moody’s
Nike, Google, Cintas and Union Pacific. We found that these
(provides credit ratings) and Home Depot (housing supplies retailer)
businesses were executing well and offered lucrative risk-reward.
have been pioneers in their industries and are current leaders with
dominant market shares.
6International
WATCHING
Due to the economic crisis brought on by COVID-19, the EU
Ric Palombi, CFA
established a €750B fund that will disperse grants and loans among
Director of Research, International Equities
EU countries. We’ve seen the recovery fund as a game-changer
from the start. The joint issuance reduces euro area breakup
risk and creates a new euro safe asset. This targeted focus on
investment and the periphery can have an outsized impact
on growth. In recent years, it’s faced significant competition from Open Fiber
Mid-June saw the launch of a landmark 10-year bond deal, (also partly owned by CDP) and a French company called Iliad.
which is the beginning of a multi-year joint EU bond issuance to Both Telecom Italia and Open Fiber have been laying fibre in Italy
help the pandemic recovery fund that the bloc agreed to last to build out a new network. This competition has put pressure on
summer. Any worry about how fixed income markets would accept Telecom Italia’s stock price, while the delay in the fibre rollout has
this new issue was quickly put to rest, as demand was ravenous. caused some in the government to support a single network to
The initial offering was double what was expected at €20B and avoid duplication, speed up the rollout and save money.
the order book was a staggering €142B. The yield or coupon on We believe a single network makes the most sense, and that the
the bond settled at a minuscule 7 basis points. probability is high that this outcome will be announced in the
coming months.
THINKING
Italy is the 4th largest country in Europe and is slated to receive DOING
€235B from the recovery fund. When all is said and done, the loans Based on our analysis, we deem Telecom Italia to be in a great
and grants will represent 14% of Italian GDP and should drive GDP position to take advantage of their market’s leading status and
growth in Italy above 4% over the next few years — a historic first due to the favourable risk-reward skew for Telecom Italia’s stock,
that makes Italy one of the key beneficiaries of the recovery fund. we’ve been steadily increasing our position.
Digging a little deeper, we find that about €50B will go towards With the first of the disbursements to begin in July and Italy set to
digitization and €34B of that will go towards funding various receive €25B of the expected €66B disbursement, we believe there
telecom and public digital infrastructure. Telecom Italia is the are multiple catalysts to drive Telecom Italia’s stock higher.
largest telecom operator in Italy and is partly owned by the
Italian government’s investment bank (CDP).
7 | INVESTMENT COMMENTARYFixed Income
WATCHING
What we were watching was the Federal Reserve (Fed) meeting,
which took place earlier this month. We’re trying to separate the Ric Palombi, CFA
noise, which will cause short-term gyrations but not have a longer- Director of Research, International Equities
term impact from the facts. This will drive interest rates and inflation
in the long run. In short, the June Fed meeting was perceived as
hawkish by investors. In response, there was material flattening of
the yield curve as short-term interest rates moved up and long-term
interest rates moved down. This is because investors are pricing in THINKING
sooner rate hikes by the Fed driven by higher inflation. The result is We expect there to be a convergence of inflation expectations,
lower economic growth. as measured by the 10-year breakevens (BE) and the 10-year bond
yield (Figure 3). The result is higher interest rates as we continue
“In essence, the market believes the on the growth path of this expansive economic cycle.
Fed is ready to curtail the economic The usual tight correlation between 10-year BE and the 10-year
bond yield has broken down, but if history is any guide, it’s
cycle, but we do not believe this is temporary. A similar, albeit somewhat smaller, deviation occurred
”
in 2013-14 as the Fed embarked on a tightening cycle. The result
the case. was that BE and interest rates did, eventually, converge. Today,
with the 10-year bond yield at 1.50% and BE hovering around 3%,
What we know instead is that that the Fed, despite having caused a similar dynamic would see the 10-year yield moving toward
some confusion, has unequivocally stated that it’s willing to let 2.25% over the cycle.
inflation run above their 2% target in order to achieve their goal of
full employment. As such, we don’t think the Fed is retreating from
its new Average Inflation Targeting, where 2% is the average – not
the ceiling.
We believe this is a “Fed fake” and that the reflation of the economic
cycle remains strong driven by consumers (pent up demand), fiscal
support from the government, higher capex from companies and a
steadfastly dovish Fed.
8 | INVESTMENT COMMENTARYFigure 3: U.S. 10Y breakevens and 10Y bond yield
U.S. 10-year breakevens (L) U.S. 10-year bond yield (R)
2.8% 4.0%
2.6%
3.5%
2.4%
2.2% 3.0%
2.0%
2.5%
1.8%
2.0%
1.6%
1.4% 1.5%
1.2%
1.0%
1.0%
0.8% 0.5%
11 12 13 14 15 16 17 18 19 20 21
Source: Bloomberg Finance L.P.
DOING
With the probabilities skewed toward higher inflation and For example, 23% of DFI is invested in floating rate debt and
higher yields over time, we continue to look for opportunities to preferred shares, both of which directly benefit in a reflationary
protect and enhance our clients’ purchasing power through the environment through higher income generation and capital
economic cycle. appreciation. Overall, nearly 70% of the pool is either protected
from or positively affected by higher inflation and higher
Figure 4 shows how the Diversified Fixed Income (DFI) strategy is
interest rates.
allocated by type of investment, and how these investments do in
a rising inflationary and interest rate environment.
Figure 4: Inflation
Directly benefits Positive Protected Limited
BY TYPE Fixed Income Preferred Shares
7% 7%
Floaters Floaters
16% 16%
CAD Hybrid Fixed resets
USD Hybrid 7% 7%
Sub Debt 3% 3%
Fixed Coupon 3% 3% 12% 12%
30% 30%
Real Return Bonds
8% 8%
Note: Percentages do not add to 100% due to rounding and cash in the portfolio.
9CONNECT WITH US CWB McLean & Partners provides clients with financial peace of mind. 1.888.665.0005 | solutions@cwbmp.com. STAY AHEAD OF THE CURVE If you would like to receive our publications directly to your inbox, you can subscribe by visiting cwbmcleanpartners.com/subscribe or by emailing solutions@cwbmp.com. The material and opinions in this report are for informational purposes only and do not constitute a complete description of our investment services or performance. The materials are in no way an offer or solicitation for the purchase or sale of any security or financial instrument. Prior to acting on any information presented you should take into account your own investment profile and if necessary seek professional advice. Information throughout this presentation, whether stock charts, quotes, articles, or any other statement or statements regarding market or other financial information, is obtained from sources which we, and our suppliers, believe reliable, but we do not warrant or guarantee the timeliness or accuracy of this information. Nothing in this commentary should be interpreted to state or imply that past results are any indication of future performance. Neither we nor our information providers shall be liable for any errors or inaccuracies, regardless of cause, or the lack of timeliness of, or for any delay or interruption in the transmission thereof to the user. There are no warranties, expressed or implied, as to accuracy, completeness, or results obtained from any information shared in this report. CWBMP.COM OBSESSED WITH YOUR SUCCESS ™
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