A case for optimism
A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty.
– Winston Churchill
One of the best examples of eternal optimism is author J.K. Rowling’s success story. Her original Harry Potter novel was rejected 12 times before it was published. Despite these setbacks, Rowling never stopped believing in her idea. She was ultimately rewarded for her perseverance, and more often than not, investors are rewarded for their optimism.
Most major global equity markets continued their strong rally from 2020 through the first 9 months of 2021. The Canadian equity market, represented by the S&P/TSX Index, led the way with a YTD price return of 15.1% (CAD). It was closely followed by the U.S. and Europe, with the S&P 500 Index and MSCI Europe Index returning 14.7% (USD) and 14.0% (USD), respectively. Emerging markets, however, have struggled, represented by the MSCI Emerging Market Index with a return of -3.0% (USD).
There are certain factors, including the COVID-19 Delta variant that may be making investors cautious. But there may be even more reasons for optimism:
Monetary policy. The U.S. Federal Reserve has defended their very accommodative monetary policy while pointing out reasons to be confident in the economic recovery. Although it’s likely that the Fed will begin to taper or reduce the amount of bonds it buys in the coming months, it’s likely to be a gradual withdrawal from pandemic-era stimulus measures.
Peak doesn’t mean weak. Equity markets seem to be reacting more to day-to-day headline news than long-term fundamentals. News of peak of market returns from last year’s bottom suggest the best is behind us. While that may be the case, any rolling over of market data merely suggests that the growth rate is slower, rather than negative.
Markets are less expensive than earlier this year. We’ve seen a strong earnings recovery globally, which has been the primary driver of returns. Despite global markets being at or near all-time highs, share prices relative to their profits have moderated. Today, investors are paying less for each dollar of profits than they were at the beginning of the year.
Strong returns can continue. During the past 30 years, investors’ returns have been positive nearly 75% of the time on a one-year rolling basis. The average calendar-year price return for the S&P 500 Index is 12.2%, but returns are more often above 20% than negative. We expect that year-over-year earnings growth for the U.S. should still be attractive well into 2022.
Almost every success story involves some bumps along the way. When it comes to investing, the best results may come to those who keep an optimistic outlook while taking an analytical approach to their portfolio.
As always, if you have any questions about the markets or your investments, we’re here to talk.
A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. –
-Winston Churchill
Economic recovery The global economy led by the U.S. continues its gradual recovery—supported by economic reopening and COVID-19 vaccine distribution. Stronger consumption is expected through 2021 fueled by consumers with excess savings and pent-up demand for goods and services. The recovery ends as the services sector catches up to the manufacturing sector’s recovery. In this environment, average market returns are expected during the next couple of years with some upside risk.
Equity markets The S&P 500 gained 8.2% in the quarter leading to a 14.4% return for the first 6 months of the year. Similarly, the S&P/TSX Composite Index was up 7.8% in the quarter and 15.7% for the first half of the year. S&P/TSX Composite growth was partly due to high oil prices, which were up 24% in the last 3 months and 51% in the last 6 months. The global economic recovery is expected to bring continued high demand for commodities and crude, contributing to higher S&P/TSX profitability for the rest of the year.
The United States The U.S. economy bottomed in the summer of 2020 and shifted from contraction to recovery. Since August, the U.S. ISM purchasing managers’ index (PMI) shows a material increase in manufacturing activity on a month over month basis. Macro indicators suggest 2021 will see a strong earnings growth environment that may include a recovery back to 2019 levels, and even stronger growth with the release of pent-up demand and excess personal savings. The S&P 500 gained 8.2% in the quarter leading to a 14.3% return for the first 6 months of the year. Moving forward, equity markets often follow Newton’s First Law of Motion—an object in motion, remains in motion. Historically, when the S&P 500 Index is up more than 20% in a 6-month period, there is a 48.6% chance it will be up more than 10% in the 6 months that follow. This is a 10% higher probability than the chance it will be up more than 10% in any 6-month period.
Emerging markets In global markets, the MSCI EAFE index was up 4.4% in the second quarter, leading to a 7.3% gain for the first 6 months of the year. The International Monetary Fund projects that many regions around the world—especially emerging and developing Asia—could grow faster than the U.S. in 2021 and 2022. On a year‑over‑year basis, global exports for the 5 largest exporters in the world seem to be improving with China leading the way.
Inflation In the near term, exceptionally low interest rates are likely to remain around the world. However, the Fed’s monetary inflation coupled with the trillions in fiscal stimulus by the U.S. federal government has resulted in a steeper yield curve. In this environment, we believe credit does well and short duration bonds outperform longer duration bonds. Credit defaults will continue through the recovery due to the effect of COVID-19 lockdowns. In this regard, security selection and careful credit analysis is of paramount importance.
As always, if you have any questions about the markets or your investments, we are here to talk.
On April 19, 2021
Deputy Prime Minister and Minister of Finance Chrystia Freeland delivered the first Federal Budget in more than 2 years. While you’ve probably seen plenty of media coverage, I thought you would appreciate an overview related to your investments and taxes.
The budget had no new personal or corporate tax rate changes. Rather, it proposes unprecedented fiscal stimulus to support the economy without any significant revenue-generating tax measures aimed at paying for this spending. You may find interesting what wasn’t in this budget. There was no increase in the capital gains inclusion rate, no change to the principal residence exemption, no family wealth tax, nor was there any income tax rate increases for individuals or corporations. But that doesn’t necessarily mean we won’t see some of these measures in the future.
Here’s an overview of some of the proposals:
New tax on luxury goods. Effective January 1, 2022, this luxury tax would apply to new, personal use luxury vehicles and aircraft priced over $100,000 and boats priced over $250,000. This would apply on both purchases (both outright and financed) and leases, with the seller or lessor responsible for remitting the full amount of the federal tax owing. Further, GST/HST would be applicable to the final sale price, including the proposed luxury tax. The tax will be calculated as the lesser of 10% of the full value or 20% of the value above the applicable threshold.
Additional Old Age Security (OAS) benefits. Seniors who will be 75 or older as of June 2022 will receive a one-time payment of $500 in August this year. Also, as of July 2022, OAS payments for individuals 75 and older will increase by 10% on an ongoing basis.
Expanded Disability Tax Credit. The Disability Tax Credit (DTC) is a non-refundable tax credit that’s intended to recognize the impact of non-itemizable disability-related costs on the ability to pay tax. Starting in 2021, the eligibility criteria for the DTC is being expanded. This will also make it easier to qualify to open a Registered Disability Savings Plan.
Enhanced Canada Workers Benefit. The Canada Workers Benefit (CWB) is a non-taxable refundable tax credit that supplements the earnings of low- and modest-income workers and improves their work incentives. Starting in 2021, the CWB is being enhanced by increasing the “phase-in” and “phase-out” rates. Also, to improve work incentives for the secondary earner in a couple, a “secondary earner exemption” to the CWB for those with eligible spouses is being introduced. This would allow the spouse or common-law partner with the lower income to exclude up to $14,000 of their working income in the calculation of their adjusted net income.
Extended COVID-19 recovery benefits. The budget includes an extension of up to 12 weeks to the Canada Recovery Benefit and 4 weeks to the Canada Recovery Caregiving Benefit.
Flexible tax treatment of COVID-19 benefits. The COVID-19 benefit amounts (e.g. the suite of emergency and recovery benefits) are normally taxable as ordinary income at the recipient’s marginal tax rate. Generally, where an individual wasn’t eligible for a benefit, the subsequent repayment amount can only be deducted from income in the year the repayment takes place. Where the repayment year differs from the year the benefit is received, an individual may owe tax on the benefit income in one year while obtaining a deduction for the repayment amount in another year. The budget proposes to allow individuals the option to claim a deduction of the repayment of a COVID‑19 benefit when calculating their income for the year in which the benefit income was received rather than the year in which the repayment was made. This would be available for benefits repaid at any time before 2023.
I hope you found these highlights helpful. As always, if you have any questions about the markets or your investments, we’re here to talk.