A letter from our CIO: The shifting picture of economic growth

Following a strong first half of 2021, financial markets endured a mixed third quarter as investors wrestled with a shifting picture of economic growth, inflation and central bank policy. On the equity side, the main indexes finally exhausted their nearly year-long run with a September sell-off, while bond yields rose late in the quarter as the U.S. Federal Reserve (Fed) delivered some clarity on its plans to begin removing liquidity from the market.

While pandemic-related headlines continue to generate noise, more pressing for markets is the Fed’s plan to begin tapering bond purchases as early as November. The Fed has been very deliberate in communicating an eventual reversal of the loose policy that has fueled the recovery, and this shift in its messaging is both a significant milestone on the post-recovery economic path and a sign that further policy moves could be in the offing.

Also significant is the upward move in bond yields that had already been happening before the Fed’s announcement in September. Since dipping as low as 1.173% on Aug. 3, 10-year Treasury yields are now back around 1.50%, and there has been a similar move in Canadian 10-year bonds. This has resulted in a weakening of long duration assets such as investment grade corporate bonds, which showed significant negative returns late in the quarter, as well as equites that have relied on low rates for a prolonged time and are now adjusting to the prospect of higher rates in the near future.

The ‘mixed’ theme in the quarter was reflected in the macroeconomic picture, as the recently strong recovery engine hit a number of bumps in the form of supply-chain issues, rising commodity prices, the Delta variant’s impact on job growth, and the deepening crisis at Chinese property developer Evergrande. My view is none of these issues are sufficient to derail the recovery, but that perhaps the path forward will not be as easy as we envisioned last quarter.

Among other things, the Fed’s announcement prompted many to bring forward their expectations for interest rate hikes, which bears monitoring, as will be the reaction of central banks in Canada and Europe that are also in various stages of their own tapering debates. Indeed, after raising its end-of-year inflation forecast in late September, many expect the Bank of England to raise rates as early as February.

Closely linked to all this is the inflation picture and the ongoing debate on how we should regard recent price spikes. My view is that while there are certainly short-term factors at play, others, such as tight labour markets and margin pressures, may be with us for a while, perhaps forcing a more prolonged definition of the term ‘transitory’.

While the pandemic continues to disrupt our everyday lives, there is a reasonable argument to be made that it is becoming much less consequential for financial outcomes. More interesting, and something we are thinking about, is interpreting its effects on human and business behaviour and how that will evolve going forward.

We were able to cross our own happy milestone this quarter as our investment department returned to our offices on Sept. 13. While we continue to follow the advice of public health officials, returning to in-person working conditions has already paid dividends through more spontaneous and real-time collaboration, as well as improved communication. There are also cultural advantages, such as better conditions for mentoring junior members of our team.

Sincerely yours,

Peter A. Zaltz, CFA

Chief Investment Officer