The pervasive capital market chatter thus far in 2021 has centered on inflation. The debate is not whether inflation exists – it certainly does – but rather the expected duration of these official 3% to 4% annualized Consumer Price Index prints. “Transitory” is the buzz word for one camp, whereas others see rising prices as longer lasting, and possibly accelerating. Market participants view each new economic data point, and word uttered by a central banker, through this lens. Putting aside the impact on our own budgets, the ultimate winner of the debate is not a trivial matter; from an investment perspective, getting the call right on changes in inflation and economic growth can lead to significantly outperforming portfolios.
To illustrate this, look no further than the MSCI All Country World Index. This broad equity index reached an all-time high during the second quarter (7.2% in local currency terms), but the intra-quarter change in leadership reflects the uncertainty of the macroeconomic environment. Early in the quarter, growth expectations and inflation fears supported cyclical sectors and commodities. Later in the quarter, as the post-COVID bounce in growth began to wane and Central Banks started making noise about tightening monetary conditions to choke off inflation (a stagflation scenario), leadership shifted to defensive sectors such as utilities.
In Canada, the S&P/TSX Composite Index gained 8.5% and broke through the 20,000 level for the first time. The TSX now leads global markets year to-date, which collectively recorded their strongest first half performance in 20 years. Oil prices, which increased 24.4% in the second quarter as part of the reflationary trade, provided support for the energy sector.
The FTSE Canadian Universe Bond Index returned 1.7% during the quarter. The Bank of Canada became more hawkish in April initiating the first phase of tapering their bond purchasing program. After rising sharply in the first quarter of 2021, Canadian Government bond yields declined in the second quarter. Credit spreads were unchanged to slightly tighter, with spread volatility particularly muted compared to recent prior quarters. The best performing segment was Provincials, with stand-out issuers being the provinces of Saskatchewan and Alberta.
As we enter the third quarter, the inflation debate rages on. Add COVID variant uncertainty on the one hand, and increased fiscal spending on the other, and one would expect market choppiness to continue. But is it all noise? Despite the temptation to forecast and frequently adjust portfolios in response to new data points or narratives, a patient and diversified approach with a long-term view remains a solid option. After all, according to some research, when forecasting inflation and growth, the highly trained economists at the U.S. Federal Reserve have been wrong 70% of the time.