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Jul 15, 2021

Q2 2021 Investment Commentary

The heatwave that Canadians recently experienced is somewhat of a precursor to what’s shaping up to be a scorcher of a summer from an economic standpoint. With 67% of Canadians having received at least one dose of the vaccine and provinces lifting even more restrictions, this will unleash many economic catalysts that we’re looking forward to.

In this commentary: 

Heat wave signals a hot economy | Canada | U.S. |  International | Fixed Income



Heat wave signals a hot economy

Scott Blair, CFA
Chief Investment Officer

The end of June saw record-breaking temperatures across western Canada. According to the CBC, the village of Lytton, BC broke a new record high for temperature in Canada at 47.9°C on June 28. The CBC also noted that this is hotter than the highest temperature ever recorded in Las Vegas, and about eight degrees above Lytton’s  previous high prior to this year. Only about one-third of homes across Alberta and BC have air-conditioning (just over 60% of Canadians have air conditioners), causing a short-term move back to the office for some workers to escape the heat. 


The hot economy 

The heatwave is somewhat of a precursor to what’s shaping up to be a scorcher of a summer from an economic standpoint. Many economists believe that the Canadian economy will grow at an almost 10% rate in Q3 vs Q2. It’s a truly staggering number that reflects a significant easing of COVID-19 restrictions. Some provinces are moving quickly. For instance, Alberta’s Open for Summer Plan took effect on July 1, with virtually all restrictions lifted. Other provinces, like Ontario, are moving forward at a more measured pace, but the key here is forward momentum.


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 Canadians had received at least one dose of the vaccine, ranking us among the world leaders. However, we still lag somewhat on fully vaccinated individuals with only around 30% of Canadians falling in that category, but we’re quickly catching up (Figure 1).


Should this momentum continue, we can expect more restrictions to be lifted such as in-class learning, a return-to-office workday in some form, and the full reopening of the border. These will all serve as economic catalysts. Whether you’re a fan of the Prime Minister or not, it’s easy to see why he appears to be leaning towards a summer election.


Figure 1: COVID-19 vaccination campaign (as of July 2)

Covid-19 vaccination chart across countries

Source: Desjardins Capital Markets and Economic Studies

Weaning off support programs 

Early on in the pandemic, we were encouraged by the size and speed of the economic stimulus introduced by world governments and central banks, but we worried about the handoff from stimulus to the real economy. As many COVID-19-related support programs roll off in Canada over the next several months, we see many indicators that our economy is ready for it:

  • 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 in the U.S. and business surveys supports the idea that there is no shortage of employment opportunities. Expect more job openings as the summer progresses.
  • Excess savings are through the roof, with the savings rate in Canada coming in above 10% for five quarters in a row. By way of comparison, our savings rate is usually in the low single digits. 
  • Disposable income has recovered. According to National Bank Financial, our disposable income levels are now back to pre COVID-19 trend levels, even without factoring in COVID-19 support programs.


Virus vigilance 

Although the short-term looks very positive, there are always clouds on the horizon to keep in our sights. The biggest one continues to be the virus and, more precisely, new variants. The delta variant that has caused so much pain in India, is more transmissible and deadlier than earlier variants. It’s already causing reopening plans in the UK to be paused and it is rapidly becoming the dominant strain in North America. Some positive news about the variant from the spread in the UK is that fully vaccinated people are well protected; this should provide more urgency to get our second shots in order to avoid any restrictions.


Despite potential headwinds, overall, the summer of 2021 is shaping up to be a big improvement over summer 2020. Summer months tend to be quieter for the equity markets, which have had a spectacular run so far this year. A breather would not be a huge surprise, since volumes tend to dry up while participants reassess in the fall.


As we continue on our journey to get back to normal, one activity you may want to consider is purchasing apparel. Clothing sales were still down over 30% from pre-pandemic levels in Canada. If we return to office workspaces (even partially) or to in-class learning, clothing could replace air conditioners as the next item in short supply at the mall – although the run on sweatpants is likely over.


Gil Lamothe, CFA
Senior Portfolio Manager, Canadian Equities


The Canadian equity markets continue to be rewarding investors through the second quarter of 2021. The S&P/TSX index was up 8.5%. This compares favourably 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, fertilizers and others.  International investors still see Canada as a resource-based economy. As they allocate capital towards our markets, we see the benefit in terms of higher equity values. Another noticeable effect of this movement of capital towards Canada has been in the strength of our dollar. To buy Canadian assets, you need Canadian dollars, and the demand for these has been a steady tailwind for our currency during most of 2021 (Figure 2).


In actual fact, much of this capital flows towards our banking stocks, as proxies for our economy. It just so happens that our banks have been deserving of these flows, as they’ve continued to report excellent results this quarter as well. The capital ratios they exhibit are very strong which, in our view, makes them among the best banks in the world. We continue to wait patiently for the Office of the Superintendent of Financial Institutions (OSFI), the regulator overseeing the banks and life-cos, to remove its pandemic-related dividend growth restrictions and to once again allow the Canadian banks to continue growing their dividends.


The energy sector has been a strong performer. Last quarter we reported that Brookfield Infrastructure’s bid to purchase Inter Pipelines (IPL) suggested that there was value in the pipeline sector. Though the oil producers have been the stronger performers year-to-date, the pipeline stocks have also done very well this quarter. Furthermore, Pembina Pipelines (PPL) has also placed a bid that was supported by IPL management, to purchase IPL. Brookfield has since sweetened its bid in an attempt to woo shareholder support.


Another acquisition drama is unfolding within the transportation sector, more specifically, in the railways. In late March, CP Rail (CP) made a bid to purchase Kansas City Southern Railroad (KSU), an American railway that operates into Mexico. By the end of April, CN Rail (CNR) came out with a significantly higher bid for KSU. CP,  perhaps wisely, decided that it would not try to outbid CNR and risk overleveraging its balance sheet. Whether or not CNR is successful with its bid is now in the hands of the Surface Transportation Board, the regulating body in the United States.

Figure 2: S&P/TSX vs. Bank of Canada Commodity Avg. Price Index

S&P/TSX Index vs. Bank of Canada Commodity Avg. Price Index

Source: Bloomberg



We’re hopeful that Pembina Pipelines will succeed in their bid for IPL. The company outlined a very cohesive plan for the merger. The synergies and resulting efficiencies suggest that the combined businesses would result in a more valuable single company.

On the other hand, we’re somewhat less excited about the CN Rail bid for Kansas City Southern. CNR is paying a premium for KSU, as well as a break fee embedded in CP’s original deal with KSU ($700 million). This will impact the quality of CNR’s balance sheet for several years. There’s also a large amount of regulatory risk involving whether, and in what form, a merger might be allowed. CN Rail previously argued that the existence of KSU provided ample competition to them, when advocating for their purchase of the Illinois Central Railway. It’s difficult to see how the regulator can ignore that argument when considering whether to allow CNR to remove that competitor. There’s still much to unfold in this story, and we’ll continue evaluating things as they evolve.



We’ve been relatively busy in the portfolio during the second quarter. The addition of Agnico Eagle Mines (AEM) gives us some 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.

The company has a very measured approach to mine expansion, with a solid pipeline of options in this regard going forward. The geographic concentration within Canada, with smaller mines in Mexico and Finland, minimize the political risk with which many other mining companies are faced.

Within the energy sector, we’ve increased our holdings in both Suncor (SU) and Canadian Natural Resources (CNQ), as well as having added TC Energy (TRP). The energy sector continues to rebound from what was a particularly harsh cycle bottom in the opening months of the COVID-19 related shutdowns, just over a year ago. As the world begins reopening, the energy sector should enjoy a steady tailwind of demand. It’s worth noting that the WTI oil price has increased from $60/barrel at the beginning of April to $73 more recently.

Sticking with the commodity theme, fertilizer prices have been 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 to upwards of 13.5 million tonnes, a record for the company. We’re cautiously optimistic that this strength will continue into year end, though fertilizer markets can be quite volatile.



Liliana Tzvetkova, CFA
Portfolio Manager, U.S. Equities

Saket Mundra, CFA, MBA
Portfolio Manager, U.S. Equities


“Expect the unexpected” seems an appropriate adage for U.S. market performance in Q2. The whole world has been talking 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 the best performing sectors in Q2, when at the end of Q1 it was all about banks, industrials and materials?

The tug of war between market participants continues with the ongoing debate about whether inflation is a long-term issue or whether it’s just transitory. Reopening and recovery have helped certain sectors and businesses, such as banks and car companies, over the past 9–12 months. Ultimately, this led to outsized earnings growth from trough levels last year and analysts have been forced to revise earnings higher, driving stellar equity market performance. However, during the past month investors have started to think about peak levels of growth and demand, which ultimately affects earnings growth and revisions.


With over 50% of U.S. adults at least partly vaccinated and many states already reopened, it’s fair to question if the demand can continue at these unprecedented levels supported by new sectors such as restaurants and travel, while the work-from-home  beneficiaries recede to normal levels. If this isn’t a hard enough question to answer, the market is further looking at the impact of more stimulus through a large U.S. infrastructure deal, debt ceiling and the hand-off from government to private sector in the coming months. And finally, the virus remains a wild card with newer variants, especially in some of the less vaccinated parts of the world.



While all these questions are extremely important, we aren’t taking our eye off the ball: we will continue to focus on investing in quality business when the risk-reward is favourable. It’s easy to get lost in the debates of growth versus value or inflation versus disinflation – losing sight of the forest for the trees. To us, the more important question is if the industry or the business that we’re invested in can reinvest 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 and stay for a long period of time to ultimately reward patient investors and owners.

While we agree that macro variables and policy actions play an increasingly important role in the markets, we’re also aware that they’re inherently complex to predict on a consistent basis. Hence, we strive to strike a balance by investing in businesses that we expect to navigate and thrive under various economic environments.



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.

We exited two of our positions wherein our thesis either played out or had less probability of materializing. These were eBay and Merck. We initiated positions in two new securities, Moody’s and Home Depot, both of which met our quality and value thresholds. Moody’s (provides credit ratings) and Home Depot (housing supplies retailer) have been pioneers in their industries and are current leaders with dominant market shares.

Both companies have mid-high single digit growth opportunities, generate high returns on capital and have appropriate balance sheet with valuations that we deem to be lucrative. We also added capital to existing names such as AutoZone, Booking, Visa, Gentex, Nike, Google, Cintas and Union Pacific. We found that these businesses were executing well and offered lucrative risk-reward. 



Ric Palombi, CFA
Director of Research, International Equities



Due to the economic crisis brought on by COVID-19, the EU established a €750B fund that will disperse grants and loans among 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.

Mid-June saw the launch of a landmark 10-year bond deal, which is the beginning of a multi-year joint EU bond issuance to help the pandemic recovery fund that the bloc agreed to last summer. Any worry about how fixed income markets would accept this new issue was quickly put to rest, as demand was ravenous. The initial offering was double what was expected at €20B and the order book was a staggering €142B. The yield or coupon on the bond settled at a minuscule 7 basis points. 



Italy is the 4th largest country in Europe and is slated to receive €235B from the recovery fund. When all is said and done, the loans and grants will represent 14% of Italian GDP and should drive GDP growth in Italy above 4% over the next few years — a historic first that makes Italy one of the key beneficiary’s of the recovery fund.

Digging a little deeper, we find that about €50B will go towards digitization and €34B of that will go towards funding various telecom and public digital infrastructure. Telecom Italia is the largest telecom operator in Italy and is partly owned by the Italian  government’s investment bank (CDP).

In recent years it has faced significant competition from Open Fiber (also partly owned by CDP) and a French company called Iliad. Both Telecom Italia and Open Fiber have been laying fibre in Italy to build out a new network. This competition has put pressure on Telecom Italia’s stock price, while the delay in the fibre rollout has caused some in the government to support a single network to avoid duplication, speed up the rollout and save money.

We believe a single network makes the most sense and that the probability is high that this outcome will be announced in the coming months.



Based on our analysis, we deem Telecom Italia to be in a great position to take advantage of their market’s leading status and due to the favourable risk-reward skew for Telecom Italia’s stock, we’ve been steadily increasing our position.

With the first of the disbursements to begin in July and Italy set to receive €25B of the expected €66B disbursement, we believe there are multiple catalysts to drive Telecom Italia’s stock higher.


Fixed Income

Ric Palombi, CFA
Director of Research, International Equities



What we were watching was the Federal Reserve (Fed) meeting, which took place earlier this month. We’re trying to separate the noise, which will cause short-term gyrations but not have a longer-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 sooner rate hikes by the Fed driven by higher inflation. The result is lower economic growth.

In essence, the market believes the Fed is ready to curtail the economic cycle, but we do not believe this is the case.

What we know instead is that that the Fed, despite having caused some confusion, has unequivocally stated that it’s willing to let 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. 



We expect there to be a convergence of inflation expectations, 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 on the growth path of this expansive economic cycle.


Figure 3: U.S. 10Y breakevens and 10Y bond yield

U.S. 10Y breakevens and 10Y bond yield

Source: Bloomberg Finance L.P.


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 temporary. A similar, albeit somewhat smaller, deviation occurred in 2013-14 as the Fed embarked on a tightening cycle. The result was that BE and interest rates did, eventually, converge. Today, with the 10-year bond yield at 1.50% and BE hovering around 3%, a similar dynamic would see the 10-year yield moving toward 2.25% over the cycle.


With the probabilities skewed toward higher inflation and higher yields over time, we continue to look for opportunities to protect and enhance our clients’ purchasing power through the economic cycle.

Figure 4 shows how the Diversified Fixed Income (DFI) strategy is allocated by type of investment, and how these investments do in a rising inflationary and interest rate environment.


Figure 4: Inflation



Note: Percentages do not add to 100% due to rounding and cash in the portfolio

For example, 23% of DFI is invested in floating rate debt and preferred shares, both of which directly benefit in a reflationary environment through higher income generation and capital appreciation. Overall, nearly 70% of the pool is either protected from or positively affected by higher inflation and higher interest rates.


In this quarter's President’s Update, Kevin Dehod sat down with Trevor Fennessy, Senior Planner at T.E. Wealth to discuss how a comprehensive financial plan can help achieve lasting financial stability and peace of mind. Click here to watch the video.