“Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.”

– Paul Samuelson

Inflation and Market Madness

Who would have thought that being able to shop in a store would be a highlight of the summer? After a long 16 months of living through the WHO-declared pandemic, a relatively-successful vaccine roll out is allowing Canada to reopen; as of June 30th, 68.2% of Canadians have received at least one dose of a COVID-19 vaccine, with 30.9% being fully vaccinated, compared to 11.0% of the world population. The progress is leading to a stark recovery as Canadians look for ways to spend their pandemic savings; despite the country shutting down non-essential businesses in its two largest provinces earlier this year, Canada is one of the only G7 members (alongside the US) to see its gross domestic product expand in the first quarter, bringing it within 1.7 per cent of its peak pre-pandemic level.

As life would have it however, too much of a good thing can cause problems, and inflation has become the latest hot button issue. Producers are still scrambling to normalize supply chains to meet heightened demand, leading to price hikes. This is of particular concern in the US; while Canada’s Consumer Price Index (CPI) jumped 3.6 per cent year over year in May, America’s rose 5.0 per cent, followed by a 5.6 per cent increase in June, its largest jump since 2008. Some of this is transitory; a big jump in prices is to be expected given where the economy was this time last year. But even the Federal Reserve has admitted that some factors are proving stickier than first anticipated.

Adding to the issue is a surprising labour shortage. The US unemployment rate remains above pre-pandemic levels at 5.9 per cent, yet companies cannot find the talent to get operations back on track, with some speculating that enhanced social benefits have deterred labour force participants from returning to work. This could lead to wage hikes, something that while positive for the worker, would contribute further to inflation.

We have also experienced a bizarre level of speculation in the markets this year thanks to the rise of the retail trader. Outside of the mayhem within the cryptocurrency space, where developers are creating and promoting hundreds of new coins only for the digital assets to fail days after launch, we have seen a rising interest in “meme” stocks, companies that, because of their large short interests, have gained the favour of online investors looking to punish those betting too-heavily against struggling firms. GameStop is the poster boy of this movement, having seen its shares jump more than 1,700 per cent in January alone. Still, research has suggested that the average investor has actually lost money chasing these popular stocks. In the face these strange circumstances, where many beginners are treating markets like a casino, it is further evidence that an approach based on discipline and fundamentals, which WDS applies, is still one’s best bet.

As always, we thank you for your support and continued confidence in WDS.

Equities

Canadian markets had a very strong run these past 12 months. While things dipped in November after a surge in COVID-19 cases (Canada only approved its first vaccine in December), a strong domestic economy and favourable terms of trade allowed for a quick recovery, with the S&P/TSX Composite Index ($TSX) ending the period at 20,166, just below its all time record set earlier in June. Year-to-date, this represents a return of 15.7 per cent, 17.3 per cent if you include dividends.

We finally saw a bit of a shake up regarding sector performance. Information technology, the running champion, saw a below market average total return of 13.2 percent over the past six months. Meanwhile, energy had its moment in the spotlight amid higher oil prices, achieving a total return of 33.2 per cent.

US stocks had a good start to the year as well, with the S&P 500 Index ($SPX) seeing a total return of 15.3 per cent. In Canadian dollar terms, however, the return falls to 12.0 per cent.

Internationally, the MSCI EAFE Index ($MSEAFE) rose 11.5 per cent (total return) in U.S. dollar terms; while behind North American equities, it remains a sizeable gain. The positive performance can be attributed to strong inoculation; roughly half the population of the United Kingdom is fully vaccinated, with the Eurozone’s own progress being on par with Canada. In less developed countries however, vaccines have been harder to access, with progress in countries like India only being made with the reinstatement of social-distancing practices and lockdowns. Herd immunity in these areas is not expected before 2022.

Fixed Income and Interest Rates

While there has not been any movement in Canada’s Policy Rate since the beginning of the pandemic, things may soon change. In May, the inflation rate rose 3.6 per cent, well above the central bank’s target of 2.0 per cent. Some of this will prove transitory, and the Bank of Canada only plans on winding down its $3B a week of bond purchases and reversing low rates if longer-term inflation rises, however some factors are likely to persist. Housing costs, for example, were a primary driver of May’s inflation and show little sign of receding. The area as a whole continues to present a perilous challenge to the Bank of Canada: with the average Canadian home being 38 percent more expensive than last year, the central bank will need to eventually rein in the hot market without bankrupting the Canadians who may not be able to afford a mortgage rate hike.

The bond market appears to be factoring in higher interest rates. Year-to-date, 10-year Canada bonds have seen their yield double to 1.39 per cent, while the FTSE TMX Canada Universe Bond Composite Index fell 3.8 per cent. With rates expected to eventually rise, many are waiting for a better deal on bonds.

Inflation concerns are higher in the US, where Joe Biden extended stimulus measures in the latter-half of the pandemic. The Federal Funds Target Rate Range remains at 0.00 – 0.25 per cent for now, however Federal Reserve Chairman Jerome Powell has now moved up his timeline for rate hikes to 2023, something that may be accelerated further still should things continue to heat up. As in the past, one could expect Canada’s own monetary policy to follow suit.

Currencies

The loonie ($CDW) rallied to levels not seen in 6 years, ending the second quarter at $0.81 USD. Year-to-date, this represents an increase of 2.4 per cent. While US inflation concerns could have contributed to the boost (a weaker denominator means a stronger Canadian dollar), the more-likely cause is the strong recovery in oil prices. With economies re-opening and inflation rising, demand is surging for resources. Given Canada’s role as an oil exporter, the loonie is highly correlated to the black stuff. In 2015, it dropped below $0.70 USD when there was a supply glut. Now that crude is recovering, it is taking our dollar with it.

Another contributing factor to the loonie’s rise was our country’s balance of trade. Canada experienced a monthly trade deficit all throughout 2020, but starting in October the gap began to narrow, with exports actually outpacing imports in January. In May however, the country saw a merchandise trade deficit of $1.4B. Our strong dollar is likely playing a role; while trade can influence our currency, our currency can likewise impact trade, and a strong loonie means cheaper foreign goods. Metal and mineral products appear to be of particular interest to Canadians; the category saw imports rise 17.7 per cent in May.

Commodities

After years of pessimism and many abandoning hopes for the $100 barrel, oil is finally making a come back. The West Texas Intermediate ($WTIC) surged past pre-pandemic prices and ended the second quarter at $73.47, a 51.4 per cent increase. Considering oil futures went negative last year, it is a welcome sign for the industry, yet headwinds remain. With the recent axing of the Keystone XL pipeline here in Canada, Joe Biden has demonstrated a clear intent to push forward on promises made in his campaign to cut back on fossil fuels.

Meanwhile, gold ($GOLD) has ended the first half of the year down 7.0 per cent at $1,765.43. One would think we would see a surge in demand given inflation concerns. In truth, market optimism around vaccine roll outs is outweighing inflation woes, with many subscribing to the idea that prices will normalize once pent-up demand subsides.

We should also give an honourary mention to lumber. With many stuck at home and looking to renovate, prices rose drastically from $259.80 USD per 1,000 board feet in March 2020 to $1686.00 in May 2021 before settling at $716.00 in June. Heightened demand isn’t all to blame; lumber producers actually decreased capacity going into the pandemic, having struggled with demand since the financial crisis. If only they knew.

This report is provided for your information. Conclusions and opinions given do not guarantee future events or performance. Facts and data provided are from sources we believe to be reliable, but we cannot guarantee they are complete or accurate. This report is not to be construed as an offer to sell or a solicitation of an offer to buy any securities. Before making an investment or adopting an investment strategy, each investor should review his investment objectives with their investment advisor. Watson Di Primio Steel (WDS) Investment Management Ltd. and individuals and companies who are related may, at any time, buy or sell securities that are hereby described in this report.