It has been a few months since my last letter. I hope this message finds you safe and healthy and reflecting on the past year with gratitude. At IPC, we have great hope for the possibilities ahead in 2021.
The first point to make is that the experience of the past 12 months should give all investors pause for thought. I’m willing to bet that this time last year no one (including us) was forecasting that a pandemic would rip through the world in 2020, causing the biggest fall in global GDP since World War II. What’s more, I’m similarly willing to bet that anyone that did predict such an event failed to forecast that stock markets would end the year at a record high. The pandemic is a useful reminder of Keynes’ principle of fundamental uncertainty – some things are simply unknowable before they happen.
In such circumstances, the key is to respond to events as they unfold, isolate what does and does not matter, and identify the factors that will shape what comes next. On that front, the three big macro themes of 2021 will be recovery, catch-up, and accommodation.
Recovery
Developments over the past month have prompted us to assume that governments will distribute vaccines on a sufficient scale to quash the virus in most developed economies and therefore remove the need for widespread restrictions on activity. The result is likely to be a significant recovery in global GDP in the second half of 2021.
The scale of the shock caused by the pandemic has made the usual GDP data misleading: 2021 is likely to see one of the fastest rates of global GDP growth on record, but this needs to be viewed in the context of the huge slump in GDP last year. The correct way to view the recovery is to focus on levels of output. Our expectations are that global GDP will return to its pre-virus level by mid-2021 however, the rate of growth will remain below its pre-virus trend for longer. We expect that gap to be closed by around 2024, but this will be a long climb and with hiccups along the way. Key to the recovery will be virus containment and fiscal policy support. Nonetheless, this improvement in economic fundamentals should bode well for markets, especially for cyclical assets, such as industrials, consumer discretionary and material companies. Our Counsel Strategic Portfolios remain overweight equities and have added exposure to more cyclically oriented sectors and regions. We are also overweight in the High Yield and Emerging Market (EM) areas of the credit markets. With that said, we continue to focus on portfolio diversification and resiliency given the path of potential outcomes remains unusually wide amid this unresolved health crisis.
Catch - Up
The second theme is likely to be one of catch-up. Some economies (notably Spain, India, France, and the UK) have been hit particularly hard by the pandemic and remain depressed. Others (such as China) have already rebounded. The result is that the virus has produced a wide variation in economic outcomes. These divergences won’t disappear in 2021, but they are likely to narrow as vaccines are rolled out and the hardest-hit economies start to find their footing. A wide divergence in economic outcomes is a positive environment for active management, and as a result, we expect that our active, non-benchmark strategies, such as global small cap and real estate, will do well in this phase.
Accommodation
The final theme of 2021 is likely to be continued accommodation by the world’s major central banks. This year’s outlook has brightened but most countries face a difficult first and even second quarter and economies will remain dependent on continued policy support. Indeed, one of the biggest risks to the outlook is that governments could pull the rug from under the feet of the recovery by removing fiscal support too quickly. All of this points to monetary policy having to remain extremely accommodative with important consequences for financial markets. The prospect of continued monetary accommodation should keep bond yields low, which, against the backdrop of economic recovery, should mean a generally positive environment for risk assets like equities and higher-yielding bonds. But, the interesting calls lie in the differences between markets: the U.S. dollar is likely to weaken against other G10 currencies, but particularly so against high-beta ones like the Canadian and Australian dollars; local currency government bond yields in most EMs should fall, providing opportunities for our global fixed-income exposure while reducing our credit and duration risk in our fixed-income exposure.
Positioning
The recovery in activity and ongoing improvement in corporate profits support a rebound in cyclically sensitive assets and economic regions, such as Europe, Japan, and EMs, which have meaningfully lagged market leaders like big tech since the market bottom in March. We are actively positioning our Strategic Portfolios to capitalize on this theme, but we remain highly selective on where we obtain the desired cyclical exposure. Specifically, we have slightly over-weighted, International equities, global small-cap equities, and global real estate, for the very reason that global manufacturing recovery should bolster sectors such as industrials, materials, and semiconductors. Focused fiscal stimulus efforts and healing in the labour market should aid personal savings and consumption, benefiting the housing and consumer durables sectors. Our investment specialists in these asset classes are positioned to benefit from these themes.
Throughout 2020, we maintained various levels of hedging exposure on the US dollar, Euro, and Great Britain Pound (GBP). At the moment, we have a 50 percent hedge on the Euro and a smaller hedge on the USD and GBP as we balance risk reduction with the benefits of the foreign market and currency exposure. Our longer-term expectation is that the Canadian dollar appreciates, and we expect that our hedging of the USD should increase through 2021 as we see a reduction in major near-term risks that virus containment fails and timelines for mass vaccine distribution elongates.
Overall, within our portfolios, we are overweight risk assets, both equities, and credit. Valuations appear rich on an absolute basis, but low-interest rates, policy support, and profit growth improvement should be supportive over the cyclical horizon. Additionally, the low-yield environment could act as a tailwind for risk assets through increased demand from investors who face a tough choice between increasing risk and reducing their return expectations.
Final thoughts
Like you, I eagerly anticipate calmer waters ahead in 2021. Last year will be a historic year thus far in my life and career. This tragedy and its economic and health effects has touched every single person on this planet in one way or another. For my part, I will look back on 2020 with a positive lens, focusing on the blessings of family, friends, and colleagues. At Counsel and IPC, we expect the global economic recovery to continue in 2021. Our base case is that the pace of the recovery will be gradual, but the trajectory of the pandemic and the magnitude of additional policy support for fragile economies have the potential to stall or accelerate the recovery. Whatever the path 2021 takes us on, I am reminded in this moment of the words of Marcus Aurelius, the great Roman Emperor.
“Our actions may be impeded…but there can be no impeding our intentions or dispositions. Because we can accommodate and adapt. The mind adapts and converts to its own purposes the obstacle to our acting. The impediment to action advances action. What stands in the way, becomes the way.”[1]
You get the idea. What you do, or how you navigate through the cycle is what matters. At Counsel and IPC, we continue to adapt to the changing market conditions in order to preserve and grow our clients’ wealth in a responsible and prudent manner. Whether the obstacle be large or small, we are turning the obstacle into an opportunity for action. My team and I look forward to serving you in 2021 and thank you for your commitment.
Until next time, stay safe and be well.
Corrado Tiralongo
Chief Investment Officer