On the high-flying TSX and the global recovery
Q&A from Tyler Mordy’s road trip
After a 20-month lockdown we are back on the road visiting clients. The economy is ripping, yet consumer confidence is hitting new lows. Predictions of stagflation have surfaced. Thankfully, clients were eager to engage. It has been a strange few years, and it continues to be strange. Needless to say, our clients were spring-loaded with questions. Last time, we presented our views on a couple of the most pressing concerns. Below, we address two more.
The TSX is soaring this year. Can it continue?
As of Dec. 3, the Canadian stock market is up by more than 18% this year. Last year’s peak-to-trough decline was 37%. All of this is unsurprising. Canada is a highly cyclical economy, moving in a “high beta” fashion to the gyrations of the world economy.
The question, then, for the globally-minded investor should be about Canada’s performance relative to other cyclical economies and even sectors. Here, several macro headwinds remain for our country. Most conspicuously, Canada still carries the weight of substantial credit imbalances. Total household debt has far outpaced disposable income and wages. And contrary to the successful private sector deleveraging episodes that occurred in the U.S. and Eurozone since 2008, Canada had no such reckoning.
Another longer-running macro issue still exists. At its core, Canada has been far too complacent in strengthening its international competitiveness. Our country relied on currency depreciation throughout the 1990s, then the commodity super-cycle boom in the 2000s, and, most recently, the housing and credit excesses of the 2010s for growth. A key issue is that Canadian businesses have persistently under-invested in productivity-enhancing processes. Looking ahead, productivity improvements take time. What is the chance that Canada will outperform its more competitive global peers over the coming years? Adding it all up, Canada is destined for middling performance. Better opportunities exist in other cyclically oriented regions with better macro prospects and lower valuations.
Can the global recovery continue? Or is stagflation in our future?
In one client presentation on the road, we discussed seven reasons why this cycle would be unlike any in the last four decades – and far different than the post-2008 rebound. Consider that the last decade was characterized by slow growth, disinflation, and skittish investor sentiment. Secular stagnation, muddle-through, and a “new normal” were the dominant narratives. A series of deflationary shocks supported the view, most notably America and the Eurozone’s multi-year household debt deleveraging. Related to the inflation question, the central issue was a deficiency of aggregate demand.
This is clearly a very different recovery than the one after 2008. Many are still misreading this, mistaking the coronavirus crisis for another 1999 or 2008. It is not. This is because the terrain upon which the virus landed is far different. No major global imbalances existed in early 2020. In fact, most imbalances had largely been worked out in the post-2008 crisis period. That meant that should the threat of the virus recede (as we are working through now), the cyclical rebound would be immediate and explosive.
What’s more, it is now obvious that the world is undergoing a massive shift in the way business is conducted. What is less obvious is that the pandemic has offered a rare opportunity to kickstart sluggish economies. Yes, the supply chain is currently a snarled mess. But it’s also an enormous opportunity for durable productivity gains. A crucial missing element of both the recoveries in the early 2000s and after 2008 has been meaningful capital spending. Yet the U.S. is now seeing the strongest capital expenditure cycle since the 1940s. Measures from other countries and regions show similar dynamics.
On the consumer side, another missing feature of previous recoveries has now appeared: wage gains. In fact, wage growth has been the highest at the lower end of the income scale. This is where the marginal propensity to consume is higher and will trigger a sustainable pickup in velocity. Global consumers also have far more robust balance sheets, with more savings to be spent earlier in the cycle.
Finally, on the government side, the pandemic has been a moment of revolutionary break. Stimulus arrived fast and furiously. And a consensus amongst policymakers has emerged: The risks of doing too little greatly exceed the risks of doing too much. Deficit shaming and austerity are now dead.
All of this adds up to an economic cycle that is not only likely to last for several more years, but will also see higher GDP growth than the last decade. With this backdrop, the case for a stagflationary outcome in the next few years is not strong simply because demand is there to offset the impact of rising prices.
Enough data points support a robust economic cycle. Yet most investors end up anchoring on the prior regime, assuming that the low growth era of 2009-20 and the associated investment leadership (U.S. growth stocks, bonds, etc.), will remain in place. This includes the long-duration growth tech stocks that have become today’s darlings. But investors need to position for an investment regime change. That means broadly staying with a reflationary bias and cyclical-orientation in portfolios. Markets are nowhere close to pricing any of this in.
Next time: More Q&A on cryptocurrency and the outlook for China.
Tyler Mordy, CFA, is CEO and CIO of Forstrong Global Asset Management Inc., engaged in top-down strategy, investment policy, and securities selection. He specializes in global investment strategy and ETF trends. This article first appeared in Forstrong’s Global Thinking blog. Used with permission. You can reach Tyler by phone at Forstrong Global, toll-free 1-888-419-6715, or by email at email@example.com. Follow Tyler on Twitter at @TylerMordy and @ForstrongGlobal.
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