We expect the Canadian economy to improve in 2021 as vaccines are distributed and individuals are both permitted and feel comfortable resuming a more normal life. Overall, Canadian consumer and business balance sheets have been spared the full economic impact of the COVID-19 pandemic, supported by generous government support and accommodative financial markets. In the case of consumer households, savings rates have spiked and a reversal of this trend could provide further economic growth throughout 2021. Economic challenges are likely to include some reduction in government stimulus as normalcy begins to return.
At the time of writing this, the S&P 500 Index and S&P/TSX Composite Index have nearly completely erased all declines from early 2020, meaning the quick “recovery trade” is likely behind us. Looking a bit below the surface, we do believe there remain attractive opportunities as some sectors are trading at excessively high valuations while others are well positioned for future gains.
It is well known that the next few months are going to be challenging economically and personally, before we can return to a more normal environment as vaccines become more widely available. While current headwinds could result in shorter-term volatility, we believe over the coming months investors will increasingly be focused on the post-vaccine world.
Positioning and opportunities
An important consideration in deciding where to invest is interest rates. Investing in a 10-year government of Canada bond today and holding it to maturity would result in a total return of under 0.75% per year; this is of course before the effects of inflation and taxes, both of which are very real costs. While bonds certainly do have their place, this is a difficult way to protect and compound one’s “real” savings, that is, after inflation. At the same time, we can find numerous attractive investment opportunities in Canada, which we believe offer both a superior income stream and greater capital appreciation potential. These investments also provide greater protection against inflation, should it materialize. In fact, many of these businesses could actually benefit from a modest increase in inflation and interest rates caused by improved economic activity; this cannot be said of most fixed-income investments.
Investors in high quality and attractively valued Canadian businesses are getting the best of all worlds today. We have found a number of these businesses across the consumer staples, financials, energy and energy infrastructure sectors. In the vast majority of reasonable economic scenarios, we expect the businesses we own today to have higher earnings and cash flow over the coming years. This is due to their robust balance sheets, attractive moats around their business, experienced management teams and strong free cash flow, which can be either reinvested or returned to us in the interim. When combined with the fact that these businesses trade on average at very attractive multiples, on both an absolute and relative basis, we believe there is the ability to earn an even better return than the dividend yield and rate of earnings growth would suggest.
We remain focused on risk and are also being mindful of unforeseen circumstances which could arise as the world returns to normal. Examples of this could include higher interest rates and/or inflation, which have the potential to drive volatility across different sectors and asset classes. We believe the portfolio is well positioned for a world that will gradually become somewhat more normalized, however barriers to returning to a more normal environment are possible.
Having your support through what has been a difficult year for all of us has meant a lot to both myself and our team. We have remained disciplined in our process but flexible in our application, allowing us to get through this very volatile period. Thank you for your confidence, and we will continue to work hard to protect and compound your savings.
Sources: CI Global Asset Management as at December 23, 2020.
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Published December 31, 2020.