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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 | Fixed Income | Canada | U.S. |  International  



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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.


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.


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.


Fixed Income

Malcolm Jones, MBA, CFA
Senior Portfolio Manager, Fixed Income



The last three months have seen a lot of volatility in the yield curve with very little net movement. Numerous central banks provided stimulus and support through the COVID-19 crisis. As we begin to emerge from this pandemic, central banks are looking at the path to remove this stimulus. The speed of the recovery, and of the central bank’s response, differs across regions.


Inflation concerns are definitely topical. During this quarter, we saw some large inflation headline numbers. Some of this can be  explained away by the base effect. A year ago, economic figures were unusually depressed. Beyond this base effect, there are other factors at play, including supply chain issues, wage inflation, demographics and geopolitical tension.


Credit spreads remain relatively narrow when compared to historic norms. There do not appear to be imminent forces to drive these spreads back to normal levels.

We’re watching the market’s ability to absorb a forecasted higher-than-normal level of debt issuance. We’re also watching for continued signs of a robust recovery.


Currently, we’re expecting Canada and U.S. yield curves to continue to move upwards and to steepen. Given that we’re going into the summer months, it’s entirely possible that another three months will pass without a significant move in the yield curves. 


Both the U.S.’ and Canada’s central banks have argued against expecting increased bank rates anytime soon. The definition of “soon”, however, is subject to change. Both central banks are starting to talk in a manner that will encourage market watchers to bring forward their expectations of the next rate hike. Current expectations are for early 2023 or even late 2022.


The Bank of Canada (BoC) has already moved to reduce its pace of bond purchases and the Federal Reserve Bank (Fed) hinted at doing the same, possibly as early as their next meeting (July 2021). The European Central Bank (ECB) notes that it feels Europe is recovering, but at a slower pace than North America. As such, the ECB feels that central bank accommodation is likely to continue for an extended period of time.


The Fed and BoC have suggested that they’re content to let inflation run above their 2% target for a period of time in order for the long-term average to meet their 2% target. Higher inflation expectations, less accommodating central banks, and a potential  increase in the bank rate suggest that yield curves should rise.


We continue to feel that there is net upwards pressure on yield curves. As such, we’ve maintained our underexposure to duration (exposure to interest rate movement) this quarter.


We have maintained a very short duration in sovereign bonds. With an expectation of rising long rates and no credit spread, our expectations for long sovereign bond returns are quite poor. Sovereign bonds still play a strong role in risk control.


We’re expecting to collect extra spread in our credit bonds, and believe this should more than compensate for losses from holding longer-term credit products.


One change to highlight this quarter was the selling of our CN Rail (CNR) position. CNR is in discussions to purchase Kansas City Southern Railway. We think this purchase will proceed (in whole or in part) and that CNR’s debt level will substantially increase as a result. While we don’t feel that the CNR will have difficulty paying this extra debt, it does add to their risk profile without any additional compensation to bondholders. We used the proceeds from the CNR sale to solidify a position in Honda Credit Canada. 



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.

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.


S&P/TSX Index 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 increased our holding in Suncor (SU) this quarter. 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 experience a steady tailwind of demand. It’s worth noting that the WTI oil price has increased from $60.00 per barrel at the beginning of April to $73.00 at this latest quarter, end of June 30.

Another stock getting our attention has been Magna (MG). They reported an excellent fourth quarter of 2020 and followed that up with a very good first quarter of 2021. The company continues to get traction in electric vehicle subcomponents. They’ve announced a recent agreement with Fisker to produce its all-electric SUV, beginning in November 2022. The auto industry has recently experienced a shortage of microchips, which has impacted production volumes. We view this as temporary and have used the related share price weakness as a buying opportunity.



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 towards growth stocks. While we’re aware of the quarterly numbers, we focus on investing to enhance the portfolio for the long run.

We exited two of our positions where our thesis either played out or had less probability of materializing — namely Becton Dickinson and Merck. We initiated positions in two new securities, Moody’s and Gentex, which met our quality and value thresholds.

Moody’s (provides credit ratings) and Gentex (supplies automotive mirrors) have been pioneers in their industries and are current leaders with dominant market shares of ~40% and 94% respectively.

Both companies have mid-high single-digit growth opportunities, generate high returns on capital and have appropriate balance sheets with valuations that we deem to be lucrative. We also added capital to existing names such as Accenture, Alphabet, Anthem, Costco and Waters. 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.