Investors breathed a sigh of relief as they turned over their calendars at the end of 2020.
Few were sorry to see the back of a turbulent year that drove nation after nation to their worst economic contractions in generations: over the course of 2020, the U.S. gross domestic product shrank around 3.5 per cent, according to the Bureau of Economic Analysis in the U.S., but still fared slightly better than Canada — where Statistics Canada estimated GDP shrank by just over 5 per cent — and the U.K., which suffered an eye-watering 9.9 per cent drop in GDP, according to the U.K.’s Office for National Statistics.
But the switchover from 2020 to 2021 marked more than a purely symbolic fresh start, since the new year also brought a measure of closure to some of the most disruptive geopolitical issues in recent memory. In Europe, Brexit finally came to an end as the U.K. and the European Union formally settled the terms of their long divorce in a last-minute deal, while Joe Biden assumed the U.S. presidency in a (mostly) peaceful transition of power. These developments have delivered a much-needed dose of stability to the markets, according to Candice Bangsund, vice president of global asset allocation at Fiera Capital in Montreal.
A new, calmer era has dawned
“We expect a more predictable and diplomatic approach from President Biden versus the volatile nature of policy-making in the previous administration, which should bring more certainty to the political landscape and incentivize businesses to proceed with investments they may have otherwise delayed,” she says.
With solid geopolitical foundations in place to build on, Bangsund is taking an optimistic view of global economic growth for the rest of the year. “While 2020 was the year of the pandemic, the stage is being set for 2021 to be the year of the vaccine, the reopening and the imminent recovery.”
Kristina Hooper, the chief global market strategist at Invesco Canada Ltd., says Canada’s increasingly internationally exposed institutional investors should also be encouraged by signs that the tide has turned on populist and protectionist movements around the world. Even Italy, a recent populist hotbed, seems to have taken a step in the opposite direction, Hooper says, pointing to the results of its latest general election, which ended with the appointment of a national unity government headed by ex-European Central Bank boss Mario Draghi as prime minister.
I don’t think it’s going to be a straight road to recovery. Every time you remove one stressor, another one comes into view.
“Leaders matter, and we’re seeing changes in leadership in some places that are causing a re-embracing of globalization. In the last year, COVID-19 accentuated protectionism, but in a funny way, it may actually have the opposite effect over the long term, because countries have emerged recognizing the importance of diversified supply chains. It’s a reversal from a place of deep protectionism, so it may take some time, but I do believe we’re on the path to greater globalization.”
In the U.S., the new president has taken every opportunity to contrast himself to his unpredictable predecessor, rowing back on former U.S. President Donald Trump’s rejection of the World Health Organization and ceasing construction on Trump’s border wall. Several cabinet appointees in the U.S. — including Treasury Secretary Janet Yellen and Attorney General Merrick Garland — even evoke the pre-Trump era, harkening back to when now-President Biden served as vice-president under then-President Barack Obama from 2009-2017.
Biden and much his administration is “a known quantity, which brings stability,” says Eric Lascelles, the chief economist at RBC Global Asset Management Inc. “Having the U.S. at the centre of power dynamics globally is a positive for investors.” Still, former Canadian diplomat Lawrence Herman, warns Canadians not to get too carried away about the Biden administration’s position on trade.
The new president to the south may find it difficult to build a case for open trade within his own party’s progressive wing, Herman says, let alone among America’s Republicans — many of whom remain dedicated to the protectionist policies of former President Trump. In any case, Herman detects a degree of continuity between the Trump and Biden administrations’ tough stances on China, as well as the current president’s promise to expand “Buy American” domestic procurement policies, enabled by exemptions in the World Trade Organization Agreement.
“We don’t have any empirical data yet, but it is likely they will have some kind of impact on Canadian suppliers,” says Herman, a senior fellow at the C.D. Howe Institute. While those lingering doubts may have been boosted by Biden’s cancellation of the Keystone XL Pipeline, Canadian money managers gave a thumbs up to his first major legislative move in the U.S.: the US$1.9-trillion coronavirus relief bill.
The stimulus plan came in larger than first expected, prompting the Organisation for Economic Co-operation and Development to revise its prediction for global economic growth in 2021, up from 4.2 per cent in December 2020 to 5.6 per cent to in March 2021. “The increased prospect for massive fiscal spending has largely overshadowed the potential for unfriendly business legislation such as higher taxes and tighter regulations under the Democratic-led administration,” Bangsund says.
“Canada will benefit disproportionately,” adds Lascelles, who predicts the U.S. stimulus will bring a welcome boost to an economy that has remained surprisingly buoyant considering the circumstances of the last year. “We’ve had the deepest recession in a lifetime, but at every turn, the economic story has been less bad than feared. When every white-collar worker in the country was sent home, you could have expected the economy to shrink by half, but in fact it shrank 18 per cent, and only temporarily.”
After a steep drop — confined to March and April 2020 — data from Statistics Canada data shows our GDP has grown in every month since, including through a second wave of coronavirus infections this past fall and winter. The impact of the third wave on Canada’s economy was still playing out as of press time in mid-April.
Defined benefit pension plans have fared similarly well, according to solvency-level studies by both Aon and Mercer, whose Canadian clients ended 2020 in roughly the same position as they started the year, thanks to strong equity market returns.
Storm clouds remain
However, there’s one factor that could change that positive trajectory at any moment, according to Lascelles: “The big wildcard issue is the pandemic.”
“COVID-19 is the single biggest driver of the economy right now,” agrees Hooper, who pegged the end of the pandemic as investors’ biggest reason for both optimism and pessimism about the near future. “The development and rollout of multiple vaccines has been very effective and much faster than expected. But the greatest risk is the development of a mutation that spreads and delays the moment when we can achieve herd immunity. It’s a game of beat-the-clock, and [as of press time in late April] more governments seem to be winning.”
Looking to the longer term, Janet Rabovsky, the Toronto-based chief investment officer at Fairwater Capital Corp., can’t wait for more conventional concerns to take centre stage. Once the pandemic fades from view, she says calmer geopolitical conditions will allow institutional investors to turn their minds to the prospect of higher inflation.
Decision-makers at both the Bank of Canada and the U.S. Federal Reserve have indicated they plan to maintain their key overnight interest rates at 25 basis points until 2023 at the earliest, fuelling speculation that inflation could blow past the two per cent target before then. “Higher inflation is not here yet, but the potential is there — especially considering the excessive government borrowing that has been going on — and people are examining what they can do to protect themselves,” Rabovsky said in an interview in March.
As a result, she predicts institutional investors in search of an inflation hedge will double down on their existing fondness for illiquid assets, including private equity, real estate and infrastructure. “That trend has been going for many years. Personally, I like these deals, but the devil is in the details: who you’re partnering with, how disciplined they are and how well they’re managed. You need to take a good look under the hood, because not everyone in a strong asset class is equally capable of delivering.”
Brighter days will come
According to Rabovsky, the long-term outlook of many institutional investors meant they were well placed to weather the economic storm wrought by the pandemic. However, she says pension plans may struggle to find some of the deals that were available in the market following the 2008/09 global financial crisis.
“They don’t need to stretch returns, so they should be sending that additional capital to do something that will benefit the plan over the long term on a risk-adjusted basis. There will be opportunities, but there don’t seem to be as many distressed sellers as we might have expected. Pricing will be critical, because there are parts of the market that are very expensive and parts that aren’t.”
At Fiera Capital, Bangsund says the firm expects equity markets to keep up strong performances for the rest of 2021. “The environment of stronger global growth, re-accelerating inflation expectations, rising bond yields and higher commodity prices should bode particularly well for the financial, industrial and resource spaces. As these sectors have a larger representation outside of the U.S., we expect more upside in markets that contain a higher cyclical exposure, such as the Canadian equity market.”
Rabovsky says the scale of economic rebound will vary widely by sector, in much the same way as did the level of damage inflicted by the coronavirus crisis. “Tech companies were able to grow because of their lack of dependence on labour and capital, while sectors like transport, leisure and retail were really hurt.
“I don’t think it’s going to be a straight road to recovery,” she adds, noting that geopolitical tensions could ratchet up again at short notice, even with a more co-operative figure in the White House. “Every time you remove one stressor, another one comes into view: extremists in the European Union; Iran, China and Russia flexing their muscles — these things haven’t gone away.”
Michael McKiernan is a freelance writer.
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