forecast - 2021

FORECAST

2021WHAT’S INSIDE

THE CYCLICAL ENVIRONMENT 1

RISKS TO OUR OUTLOOK 4

THE SECULAR ENVIRONMENT 6

FINANCIAL MARKETS 7

PORTFOLIO STRATEGY AND STRUCTURE 10

SUMMARY 13

This year’s Forecast looks at the cyclical factors influencing the shorter-term economic outlook. In addition to considering the evolution of secular forces for the years ahead, we examine market valuations and technical conditions. Taking into account all these factors, we set the framework for our portfolio strategy. Throughout 2021, updates to our Forecast will be highlighted in our monthly newsletter – Outlook.

FORECAST 2021 | Page 1

INTRODUCTIONFollowing the massive shock of the COVID-19 pandemic and ensuing economic shutdowns, a new cycle is emerging. The economic cost has been significant, US$10.3 trillion by one estimate1 , which dwarfs the GDP of every country in the world except two. According to the International Monetary Fund (IMF), countries worldwide have put nearly $12 trillion of fiscal action in place and an additional $7.5 trillion in monetary policies, in an enormous effort to prevent the health and economic crises from becoming a financial crisis. This has been a large negative jolt for society as a whole and the global economy. However, economically, the worst appears to be behind us, and with the welcome news of effective vaccines, we can begin to look ahead.

Over the next few pages, we will assess the acceleration of a number of the shifts that have been underway globally. We believe that the shift in primary policy goals from monetary to fiscal, as well as the joint policies that will result in financial repression are the most significant for investors. These supplement our main secular outcome from last year – that inflation pressures could finally take root in this coming cycle. Notably, through this, the performance of financial markets has disconnected from economic cycles for three years running now. We turn to outline our thinking on market valuations and technical conditions in light of this past year’s performance and finally, we outline our portfolio strategy.

1 What is the cost economic cost of COVID-19?, (2021, January 9). The Economist

THE CYCLICAL ENVIRONMENT For the first time in more than a decade, we are in a new business cycle. However, what transpired in 2020 was not a typical textbook recession, so the normal characteristics of a post-recession era are not present today. Our cyclical outlook must in turn account for the odd qualities of the start of the cycle. Nonetheless, with policy firmly in the driver’s seat, as long as the vaccines are effective, we can look forward to a period of global synchronized growth.

World: A Calmer and Clearer Path Ahead

• The global growth trajectory has not looked this clear in decades. Coming out of the Great Financial Crisis (GFC), there was considerable uncertainty in a significant number of areas: the state of the housing market; the depth of unemployment; the ability for low rates to stimulate demand; the path for United States (US) household balance sheet repair; and the unintended effects of then-innovative policies like quantitative easing and negative interest rates. Coming out of the recent pandemic-driven shock, there was uncharacteristic strength in housing demand and prices, savings rates, and retail sales of goods. Inventory levels fell and a tidal wave of bankruptcies were staved off by government support measures; pent up demand is high. Moreover, structural differentiators this cycle bode well – the services sector, unusually, has been hardest hit. Notably, this sector can recover faster, with no large scale factory shutdowns. Additionally, there is a large, lower-wage labour supply to tap when needed to re-staff hotels, cruise lines, restaurants, and other personal services. This makes the economic outlook solidly positive.

• All components of policy are expected to remain universally supportive for growth. Trade policy is expected to improve with the new US Administration easing relative to the past couple of years’ divisive tariffs and countervailing duties, leaving a calmer environment to expand segments of international trade. Monetary and fiscal policy will not only stay accommodative, but are likely to push demand actively higher as governments direct spending to large projects, such as renewing infrastructure. Global efforts pushed monetary and fiscal policy support to over 12% of world GDP. In aggregate, our base case forecast for global growth is positive, likely the most optimistic it has been in over seven years.

CHART 1: WORLD ECONOMY TO STABILIZE

Inde

x

Source: Organisation for Economic Co-operation & Development, World Bank, Macrobond, Connor Clark & Lunn Investment Management

Note: Indexed 2019 Q4 = 100

2020 Projection

Current Path

2019 Projection

85

90

95

100

105

110

Oct-2019 Apr-2020 Oct-2020 Apr-2021 Oct-2021 Apr-2022 Oct-2022

Activity to return topre-pandemic levels this year


Canada: Fiscal Policy and Immigration Policy Remain Tailwinds

• Shutdowns in the largest provinces this winter will give way to a strong rebound in the second half of the year, but without any inflation concerns given the large output gap that re-opened due to the pandemic. In addition to the factors described above, Canada in recent years has differed from other countries because of significant resilience in the labour market, helped in turn by positive net immigration. The influx of highly skilled immigrants did not deter the unemployment rate from trending to decade lows. As the borders reopen this year, we anticipate immigration will resume supporting domestic growth.

• Government backing for those most impacted by the virus, combined with new program spending, will result in material deficits but at the same time will contribute meaningfully to growth. So far this fiscal year, tax and spending measures pushed the federal deficit to 17.5% of GDP (C$382bn). The budget deficit is expected to remain in excess of 5% of GDP for the next two years, in conjunction with a stimulus package to “jumpstart” the economy. This is a material change – Canada has run a fiscal budget within 1 percentage point of GDP since 2013. As a result, Canada’s net debt will surge from 31.2% of GDP up to 52.6% in fiscal year 2021/22. There are two implications from this; government spending will be a net contributor to aggregate demand because of generous programs, but at a potential cost in our ability to finance our debt. Canada has run afoul of fiscal imprudence before, as recently as the mid-1990s, causing ratings agencies and foreign investors to respond unfavourably. So far, the common worldwide response to the pandemic has given governments a free pass to massive debt accumulation. However, Canada’s net debt accumulation during this crisis was the greatest amongst the advanced economies. Because we began the crisis in better shape than most, our projected debt is only slightly worse than, but broadly in line with, our AAA-rated peers. So far so good.

• The Canadian consumer has become more interest sensitive; even as the total debt levels have risen this past year, interest servicing costs have eased more than 2.3 percentage points from a year ago to just 13.2% of disposable income. While the potential for further debt-fueled spending from here is limited, a rebound in services spending helped by pent-up demand should help recreation, tourism and other services post strong rebounds. Moreover, Canada’s resource sectors will benefit from a strong cyclical recovery. Taken together, Canada’s GDP will likely post its strongest annual growth since 2000, but still lag behind the US and other G7 economies.

CHART 2: CANADA’S 2020 DEFICIT PROJECTION RANKS HIGH AMONG ITS PEERS

Deficit as % of GDP

Source: IMF, Macrobond

CanadaUnited States

United KingdomJapan

ItalyBelgium

FranceAustralia

NetherlandsGermanySweden

Switzerland

-20 -18 -16 -14 -12 -10 -8 -6 -4 -2 0

US: The Biden Era Begins

• Consumers are expected to be the dominant contributor to growth. Household balance sheets are healthy, having delevered coming out of the GFC, and aggregate savings have built up. Similarly, businesses will also benefit from the low costs of borrowing but additionally will see a surge in production from replenishing low inventory levels. Operating efficiencies will improve through investments in automation. One growing risk is the US-China relationship (see more below). However, this bodes well for companies looking to reshore production back to the US, retool supply chains, and develop redundancies and security of supply and essential goods, all of which will further stimulate investment.

• The new US Administration comes in with high expectations for fiscal stimulus, fewer trade tensions and more multilateralism in its dealings. For growth, the Democratic control over the Executive, House and Senate imply less legislative gridlock leading to more stimulus, infrastructure spending and health care initiatives. A US$900 stimulus package was passed during the last week of December, which is estimated to add some 2 percentage points to growth this year, while expectations are building for another package in the spring. One negative offset to the bullish outlook arises from a possible increase in tax rates, for both corporations and individuals. However, the environment in which President Biden will lead is different from the true “Blue Wave” given the narrowest of margins in the Senate, and any excessively progressive policies are unlikely to make it through. So higher spending is likely, but not huge tax hikes.

CHART 3: SURGE IN SAVINGS TO HELP SPENDING THIS YEAR

% o

f Per

sona

l Disp

osab

le In

com

e

Source: U.S. Bureau of Economic Analysis (BEA)

0

5

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30

35

1959 1965 1971 1977 1983 1989 1995 2001 2007 2013 2019


EU: Steps to Fiscal Unity

• The European Union heeded Winston Churchill’s words from World War II in trying to set up the United Nations - never let a crisis go to waste. The massive government solutions to the hardships brought on by the shutdowns to combat the virus finally broke the barrier to a fiscal union. The two largest governments committed to supporting collective borrowing under the EU banner in the form of the EUR672.5 billion Recovery and Resilience Facility. Its mutual debt will be bought by the European Central Bank (ECB), effectively paving a smoother path forward for the common currency. Like many in the world, Europe has rejected fiscal austerity, and government support should smooth the outlook.

• More immediately, the region has been hit hard and the winter months will flatline growth. Yet, the stunning 12.6% quarter over quarter (not annualized) third quarter rebound last year showed how much room there is to bounce back once the public health outlook stabilizes. Numerous national elections are slated over the next year, including Germany, Netherlands, France and Italy, which point to political risk. Nonetheless, the outlook is, all things considered, considerably brighter. In addition to fiscal unity, Trump’s trade tariffs will be reduced and higher longer term rates will lessen pressure on the banking system. Finally, both China and the US are interested in drawing Europe closer, both commercially and in the area of international cooperation.

CHART 4: PERIPHERAL SPREADS COMPRESSING

Perc

ent

Source: Macrobond

Italy Spain0

1

2

3

4

2018 2019 2020 2021

10Y yield spread versus Germany

China: First In, First Out

• China was the first to succumb to the virus, first to recover through aggressive lockdowns and first to see a full V-shaped recovery in its economy. It has done so without excessive leveraging. Thus, the combination of the virus’ fortuitous timing to hit early in the year, heavy-handed shutdowns, as well as the rebound in manufacturing, implies that China will likely be the only major economy to post a gain in GDP this past year.

• This will likely ease in 2021. Part of the turbo gains in the second half 2020 arose from China’s position as one of the world’s leading manufacturers of things needed to sustain working from and staying at home – electronics, housewares, toys and games. Exports have been a source of strength, rising 12%-21% year over year across various major Asian exporting nations. However, easing in spending on goods, combined with appreciating currencies will diminish trade activity. Policy will also look to normalize credit growth downward and renew focus on excessive debt levels. Nonetheless, we believe that private domestic spending can pick up the slack, particularly with wealth effects and global growth. With stronger global economic activity and marginal policy tightening, China’s GDP will be positive, but will moderate through the coming year.

CHART 5: CHINA TRADE HAS REBOUNDED WITH DEMAND FOR GOODS

Year

/Yea

r % C

hang

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Source: China Customs Statistics Information Center (CCS), Macrobond

China ImportsChina Exports

-20

-15

-10

-5

0

5

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15

20

25

2015 2016 2017 2018 2019 2020


RISKS TO OUR OUTLOOKAs we consider the widely held consensus view that the coming year will be characterized by solid growth, the risks seem minimal. While our base case forecasts are held with a high probability of coming to pass, it is at these times in particular when the not-so-obvious risks should be monitored. The first two risks that we highlight below are medium term in nature, and not projected to influence our near-term investment horizon. Over the next year, a resurgence in health risks undoubtedly remains the top concern.

1. Sustained Inflation Comes to Bear Quickly

• Perhaps the most dominant reason for the short-lived decline and forceful recovery in economic activity and market indicators were the mammoth accommodative policy measures. It follows then that the greatest risk to the outlook is a premature withdrawal of policy. To provoke that kind of extraordinary pullback in policy requires a threat, given the impact of the pandemic-closures are still widespread and require support. The most likely such trigger would be inflation.

• In our eyes, this is unlikely in 2021. Any jump in inflation measures would most likely be (rightly) written off as base effects. To be sure, households have a potent combination of high savings and pent-up demand, and there are evident bottlenecks throughout the supply chain. However, an actual sustained pace of inflation that would elicit a policy response requires that economies close the gap to their potential output, and this is not a scenario we envisage for at least a year.

• One further factor dampens the potential for a surprise policy tightening. This past year saw perhaps the single most important shift in central bank policy since inflation targeting began in 1991. In August, the Fed committed to Flexible Average Inflation Targeting (FAIT), over a non-descript time and unclear level, thereby allowing the Fed the widest flexibility in policy setting. Central banks, recognizing the risk that their policies are less effective when interest rates are near the zero-bound while debt levels have been built up, would likely cheer a normalization in inflation expectations. They will therefore resist any instinct to tighten, and remain steadfastly accommodative. Indeed, governments, on the side, may well quietly encourage this, recognizing inflation is an effective way to pay for the enormous debt load they have accumulated.

CHART 6: NOW INFLATION TARGETING IS FLEXIBLE

Year

/Yea

r % C

hang

e

Source: US Bureau of Labour Statistics, Macrobond

US Core CPI (ex-food, energy)

0

2

4

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14

1958 1968 1978 1988 1998 2008 2018

Inflationtargeting era

2. The Divide Between China and the US Widens

• In the US, there has been a consensus building that there is no longer benefit from “constructive engagement” with China and that the two countries are competitors. Similarly, in China, there is a recognition of the need to decouple their input sources from the US. The division has become clearer and the impacts will be wide-ranging, including on technology, defense, communications, capital markets, climate and health care. As an example, access to capital is being tightened; the NYSE has delisted Chinese companies and investment in these companies will need to move into new hands as China’s capital markets will need to absorb the repatriation of those listings. More importantly, however, the digitization of our everyday lives, from appliances in homes, cars and mobile devices and always-on communication implies that semiconductors remain a vital commodity of the future; much of these are produced in Taiwan. This geopolitical battleground will become critical. Interestingly, where China and the US do agree, is tighter tech regulations, on the fintech sector in China and on social media and big tech monopolies in the US.

CHART 7: A SHIFT IN THINKING ON CHINA-US RELATIONS

Inde

x

Source: Economic Policy Uncertainty, Macrobond

China Geopolitical Uncertainty Index,smoothed 6-months

2010 2012 2014 2016 2018 202050

70

90

110

130

150

170

190

210


The net result of the decline in cooperation is likely slower overall economic growth and higher inflation. Furthermore, there will likely be more jockeying and maneuvering as they try to grow their respective spheres of international influence and leadership. It is in that light that it’s worth noting trade deals are coming together that realign commercial interests. Two examples from the last couple of months alone highlight this. In Asia, a new Regional Comprehensive Economic Partnership trade agreement, under negotiation for nine years and signed in November 2020, now links the ASEAN economies with China, Japan and South Korea in a massive free trade area. Additionally, the recent Comprehensive Agreement on Investment, signed December 30, 2020, opens Chinese markets to the EU and commits to sustainable development provisions.

3. The Virus or Vaccines Trigger a Serious Growth Scare

• It is almost superfluous to mention an unpredictable exogenous shock in any risk scenario in any given year. Yet, it was the dominant influence over the world last year. As a result, we must be cognizant of potential risks related to our main near-term risk to growth, such as mutations to the virus, or some problem that renders vaccines mute. At the moment, there is no indication that this will come to pass.

• Indeed, the scientific community has demonstrated an extraordinary ability to study, sequence and combat a novel virus, and so while a devastating strain or ineffective medical response is a risk, we are unlikely to repeat the all-encompassing shutdowns and associated 30%+ equity correction that we had in spring 2020. Indeed, these current shutdowns over the winter have been associated with steadier (though occasionally negative) employment, income, spending and industrial production activity. The economic impact diminishes in each subsequent virus infection wave, as governments learn and attempt to target shutdowns to manage outbreaks.


THE SECULAR ENVIRONMENTLast year, we introduced three major changes to our secular themes that each signifies higher inflation – rising populism / reversal of globalization; monetary policy ineffectiveness; and ESG investing. Each of these is still acutely relevant. The rise in income stagnation and income inequality have been themes for a couple of years, and were joined last year by the likely reshoring of production and supply chains. The probable outcome is higher prices. Second, the effectiveness of monetary policy becomes asymmetric as interest rates are bound to the downside, while spending becomes restrained as debt levels accumulate. Finally, climate change and the desire to invest in ways that positively impact society are gaining momentum with more investors advocating for sustainable investment approaches. Over the past year, much has changed in the way we live and work, and this has significant implications for the investment environment. We have discussed this over the year in Outlook. We highlight below two secular themes that we believe have lasting implications for capital markets, in particular counteracting the upward pressure to an inflation-induced rise in interest rates.

1. High Debt Levels Precipitate Financial Repression

• From businesses to households, debt levels have risen in recent decades in response to spending supported by more attractive costs of financing. This past year, we now add governments the world over. Given not only the growth in debt this year, but also the likelihood that this will persist in the next cycle, policymakers will look to enact policies that will ease the burden of having to pay back that debt by running surpluses in the future. These include growing GDP to reduce the proportion of debt as a size of their economy, or perhaps more enticingly, inflating their way out of debt by paying down debt issued today with inflated (devalued) dollars of tomorrow.

• Government interventions, in markets and monetary policy, which lead to a capping of interest rates below nominal GDP are likely to remain in place for some time. By requiring institutions (life insurers, banks, mutual funds and their own central banks) to buy and hold government debt, yields can remain low enough to sustain debt financing. In the process, it creates distortions, transferring wealth away from savers, those who rely on higher yields for income, towards debtors. The market outcomes of financial repression include low, sometimes negative interest rates if not in nominal terms then most certainly in inflation-adjusted terms. Moreover, this also lends itself to higher financial asset prices.

• Thus, the 40-year secular bull market in bonds may be over but we do not believe that we have entered an extended bear market in fixed income assets.

CHART 8: TRAPPED WITH LOW RATES AS DEBT LEVELS SURGE

Source: The Bank for International Settlements, Macrobond Note: 2Y Bond Yield is average of US, UK, Japan, Germany, France, Spain, Italy.Government Debt as % of GDP is average of US, Japan, Eurozone, UK

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2Y Bond Yield, leftGovernment Debt as % of GDP, right

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1982 1986 1990 1994 1998 2002 2006 2010 2014 201820

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2. The Shift From Monetarism to Keynesianism

• Prior to the pandemic, government debt levels in developed market economies were already on a trajectory to grow materially based on the committed health and retirement care expenditures that come with aging demographics. Suddenly last year, previously inconceivable and “unprecedented” amounts of transfers and spending were enacted. Now running large government deficits is a state of life. Over the course of a year, unthinkably foolish government deficit spending is now thought of like an obligation to bring back sustained aggregate demand. This shift in thinking has permeated countries, policymakers and different political stripes, quieting even fiscal conservative voices. This means fiscal policy will become highly stimulative. As Milton Friedman once proclaimed: in one sense, we are all Keynesians now.

CHART 9: LARGE DEFICITS TO EXTEND FOR YEARS

Perc

ent o

f GDP

Source: U.S. Congressional Budget Office (CBO), MacrobondNote: 2020-2030 are projections prior to Biden administration fiscal plans

US Budget Deficit (-) or Surplus (+)

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1962 1970 1978 1986 1994 2002 2010 2018 2026


Equally important, zero interest rates are here not just for very short-term policy rates but all the way out the yield curve. This is because quantitative easing, normalized after the GFC, is required to keep the cost of funding ultra-low. Therefore, the past three decades of primary policy (inflation targeting) will now decline in importance. Even if inflation rises, central banks will resist raising rates. This was formalized in FAIT by the Fed and likely to be considered by others including the Bank of Canada (BoC). In effect, the Fed is no longer worried about inflation overshooting its target. Inflation is coming back and with only loose parameters defining over what period and how long or far an overshoot will be tolerated, the Fed can keep policy accommodative. If inflation does come back, propelled along by a strong fiscal push, central bankers are likely to take a kinder, softer view of it, implying a higher bar to raise interest rates. Ultimately, this implies a longer path for accommodative policy.

FINANCIAL MARKETS

VALUATIONS AND TECHNICAL FACTORS

VALUATIONS: Earnings Growth Will Drive Returns

• Corporate profits took a significant hit in 2020, as many businesses were forced to shut down or significantly scale back operations due to pandemic-related restrictions and lockdowns. The collapse in earnings was swift, but was met with a solid rebound in the second half.

• The backdrop for earnings is supportive heading into 2021, given widespread vaccine administration and ongoing accommodative policy. Economic activity should normalize, and we expect continued sequential improvement in the level of company earnings that ultimately closes the gap created in 2020, prior to making new highs in 2022. A US Democratic Congress adds to the risk of a corporate tax hike that could lower earnings projections. However, it also raises the likelihood of additional stimulus that could drive earnings higher by enough to offset tax burdens. In the US, we anticipate 28% growth in EPS from current levels in 2021, and a further 11% increase in 2022. In Canada, which is more levered to the economic cycle, we expect a 36% increase in EPS in 2021, with a subsequent 12% rise in 2022.

• Profit margins contracted sharply in 2020. Margins are set to recover in 2021, as low interest costs persist and cost-cutting measures implemented during the pandemic remain in place. Moreover, tight inventories could give firms some pricing power. Any rise in input costs is likely able to be passed through to consumers, and should not prevent margin expansion. We do not expect this cycle to differ from any other in terms of positive operating leverage that surprises to the upside at the start of the cycle as revenues recover.

• S&P 500 consensus for 2021 suggests earnings growth of 26% to $173 per share. For the S&P/TSX Composite, consensus calls for an increase of 30% to $1016 per share. Our forecast for the US, at $176 per share for 2021, is roughly in line with consensus. We believe markets will place more weighting on 2022 earnings, which we estimate to be $196 per share. In Canada, our forecast is higher than market expectations at $1070 per share in 2021, and rises to $1196 in 2022.

CHART 10: EARNINGS TO TURN HIGHER WITH IMPROVING ECONOMY

Year

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r % C

hang

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Source: I/B/E/S, TD Securities, Macrobond

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-30

-10

0

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2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

S&P 500 S&P/TSX Composite


VALUATIONS: Multiples to Remain Elevated

• Expansion in valuation multiples more than compensated for the earnings decline in 2020, with price-to-earnings ratios (P/Es) rising to levels last seen during the tech bubble 20 years ago. We expect some multiple contraction from these extreme levels, particularly in the US, but also believe that multiples will remain elevated, near the upper bound of the post-crisis range, given the easy monetary conditions and tame inflation. We expect interest rates to rise in 2021, but we believe there is room for the equity risk premium to fall further, so long as the low volatility environment persists. This allows for equity multiples to remain elevated.

• Consensus estimates call for earnings per share for the S&P 500 and the S&P/TSX Composite to come in at $173 and $1016 respectively. The consensus P/E multiple of 23.4 times for S&P 500 earnings 18.1 times for S&P/TSX earnings suggest the S&P 500 around 4,050 and the S&P/TSX should trade around 18,400.

• Our estimates are a touch more optimistic for the S&P 500, for which we use our 2022 earnings forecast of $196 and a P/E multiple of 21 times, to achieve an index target of roughly 4,100. For the S&P/TSX, our 2022 forecast of $1,196, combined with a P/E multiple of 16.8 produces an index level around 20,100. Overall, we expect an 11% increase in the US equity market and a 15% increase in Canadian equities, in local currencies, from year-end levels.

CHART 11: VALUATIONS EXPECTED TO REMAIN STABLE AT HIGH LEVELS

Forw

ard

P/E

Mul

tiple

Source: I/B/E/S, Connor Clark & Lunn Investment Management

S&P 500 S&P/TSX Composite

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28

2000 2004 2008 2012 2016 2020

VALUATIONS: Bonds Are as Overvalued as Ever

• The CC&L Fundamental Bond Valuation Models (I & II) suggest a fair value range for the US 10-Year Treasury yield is 2.3% to 4.3%. Our CC&L Technical Bond Valuation Model has improved from the record low (expensive levels) reached in March 2020, but is still indicating an extremely overvalued bond market. The US 10-year yield ended 2020 at 0.90%, over 100 basis points below what was already considered a low yield at the end of 2019. It was a historic year for global liquidity with central bank balance sheets surging to all-time highs in record time, widening the gap between fundamentals and asset prices.

• While short-term bond yields will remain anchored near current levels, longer-term yields will face upward pressure given the rosier economic outlook and firming (although not sustained) inflation. Though we expect long-term yields to rise in 2021, they will remain below what fair value models suggest.

CHART 12: BOND VALUATION PERSISTENTLY EXPENSIVE

Source: Connor, Clark & Lunn Investment Management Ltd.

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-1

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1989 1994 1999 2004 2009 2014 2019

Bonds Cheap

Bonds Expensive

CC&L Bond Valuation Model


TECHNICALS

Technical models are currently producing a wide range of signals. Out of nine technical models that we monitor, three are returning a positive signal, three are negative and three are neutral. Momentum indicators are overall flashing positive, suggesting a continuation of the favourable trend seen in equity markets in the latter half of 2020. In contrast, equity sentiment indicators are generating a negative signal on net. Sentiment indicators are highlighting extreme investor optimism (a contrarian indicator). While two of the four sentiment indicators are actually negative, the remaining two are near extreme levels. In aggregate, the signals from the technical models are relatively dispersed, suggesting a neutral signal overall.

Table 1: Technicals

Technical Models Score

50 & 200 Day Moving Average (5 markets) Positive

Citigroup Surprise Index Negative

Coppock Momentum Positive

CC&L AMSD model Neutral

Total Return Log (S&P/TSX & S&P 500) Positive

Investors Intelligence Bulls & Bears Negative

American Association of Individual Investors Bulls/(Bulls + Bears) Neutral

Bank of America Merrill Lynch Bull/Bear Neutral

Citi Panic/Euphoria Model Negative

Table 2: Financial Markets Forecast

Market Forecasts Current Base Case Range over Next Year

Global GDP 5.5% 4.5%-6.5%

S&P Earnings ($ US) 137 176

S&P P/E (x) 22.8 21

S&P/TSX Earnings ($CA) 784 1070

S&P/TSX P/E (x) 16.9 16.8

BoC Rate 0.25% 0.10%-0.25%

CAN 10-Year Rate 1.10% 0.35% -1.45%

CAN Credit Spreads 1.40% 1.25%-1.90%

CHART 13: INVESTOR SENTIMENT BULLISH - EXHIBIT I

Source: BofA Global Investment StrategyNote: As of Jan 2021

ExtremeBearish

ExtremeBullish

Buy Sell

0

2

4 6

8

10

LATEST

March 2020

7.1

0.0

CHART 14: INVESTOR SENTIMENT BULLISH - EXHIBIT II

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posit

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Source: Citigroup

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-0.91988 1991 1994 1997 2000 2003 2006 2009 2012 2015 2018 2021

Euphoria

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CHART 15: INVESTOR SENTIMENT BULLISH - EXHIBIT III

Source: American Association of Individual Investors, Macrobond

Investor Sentiment, Proportion Bullish/(Bullish + Bearish), 3-Week Moving Average

Excessive Optimism(Negative Signal)

Excessive Pessimism(Positive Signal)

20

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2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

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CHART 16: WORLD EQUITY MOMENTUM SHOWING OPTIMISTIC SIGNAL

Source: MSCI Barra

MSCI World Price IndexMSCI World Price Index, 50-Day Moving AverageMSCI World Price Index, 200-Day Moving Average

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2010 2012 2014 2016 2018 2020


PORTFOLIO STRATEGY AND STRUCTUREThis past year marks the third straight year where global economies have disconnected from financial market performance. In the last twelve months, global equity markets (MSCI ACWI) posted double-digit gains, the Canadian universe bond market index returned just under 9%, and commodities, excluding energy also gained 10%, all during the worst global recession since the Great Depression. Central banks have driven a wedge between the traditional positive correlation between economic growth and financial market performance, by flooding the financial system with liquidity.

Our technical models are sending disperse signals, as momentum indicators are generally positive but key sentiment indicators (a contrarian signal) have turned overly optimistic. To date in this market rally, equity valuations have done all the work of the equity rally, and looking forward, markets will demand earnings growth to sustain the gains. We do think there is a strong case for both earnings and margin growth. One key risk for equities remains higher yields. From our lens, some normalization of the equity risk premium, combined with a modest increase in risk-free 10-year sovereign bond yields, will still create conditions for favourable valuations. Indeed, within a higher rates scenario, fundamentals for some value-oriented sectors, like banks, will look rosier.

Bonds have been expensive for a decade, and as interest rates dropped across the yield curve, fixed income assets only got more expensive this past year; we do not see this changing yet. On the upside, negative yields are unlikely to come to North America. However, the path of rates will become less clear when sustained inflation returns. On net, we expect yields to rise modestly but remain capped well below 2.0%. Credit markets have been spared a material default cycle with central bank support for corporate debt. However, after the nine-month rally, all-in yields are at or below their pre-pandemic levels and spreads do not look to provide much value. Still, the overwhelming search for yield and return will keep both high-grade and high-yield credit well supported and we still see further gains here. Finally, the asset mix within balanced portfolios remains firmly tilted in favour of equities, and is aligned with our constructive outlook.

Asset Class Returns

• We are bullish on Canadian, US and global equities, as continued improvement in the broad economy will lift earnings expectations. In early cycle periods, those companies, sectors and regions that are the most leveraged to growth tend to outperform. Building on last year’s gains, we anticipate a gain of 11% for US equities and a slightly higher return of 15% for the S&P/TSX Composite. Europe and emerging markets (EM) could see gains similar to those in Canada. The former looks set to benefit from a modest normalization in the yield curve that is positive for banks, while EM will benefit from the rotation to early cycle sectors (industrials and commodities).

• Our base case is for the 10-year Government of Canada bond yield to rise gently through this year, trading off the lows seen last year and in the range of 1.1% to 1.25%. Given our outlook (and consensus) for inflation expectations to return over the coming years, the risks for interest rates are tilted to the upside. The BoC, aggregate Canadian debt levels, and a large output gap will likely limit any material upside above 1.5% in the near term. As such, we expect total returns for the FTSE Canada Universe Bond Index to be muted, and only near its running yield of 1.2%.

• Our asset mix strategy favours global and Canadian equities in equal measure, as the downside headline and economic risks abate. We maintain an underweight in bonds after the run-up in prices in the wake of the global deflation scare last year. We believe the environment of accommodative policy will extend for some time, leaving us constructive on risk assets.

CHART 17: EQUITIES SET FOR ANOTHER STRONG YEAR

Year

/Yea

r % C

hang

e

Source: Toronto Stock Exchange, FTSE Global Debt Capital Markets, Macrobond

-40

-30

-20

-10

0

10

20

30

40

50

60

70

1989 1994 1999 2004 2009 2014 2019

S&P/TSX Composite Total Return IndexFTSE Canada Universe Bond Index


Stock and Sector Selection

• Despite our constructive outlook for stocks, the upcoming year will becharacterized more by a change in leadership, in comparison to the 2020experience. In a shift from prior years, our fundamental equity portfolioshave rotated from bond proxy sectors, such as consumer staples, utilitiesand telecommunication companies, into cyclical and more value orientedstocks, which typically do well at the start of a new cycle.

• Thematically we believe that global fiscal stimulus will have a significantimpact on equity performance in 2021 and 2022. We expect fiscal stimuluswill be very supportive for infrastructure spending, domestication ofsupply chains, health care, education and ESG investing with a focus onreversing climate change. Extending a secular theme from last year, weexpect that valuation multiples on renewable stocks and alternative fuelstocks, such as hydrogen and electric vehicles, will see multiple expansionwhile valuations for companies that are associated with polluting fuels willsee multiple contraction.

• Our views for equities in the US account for the change in the balance of power in the Senate, with the win by the Democrats in theGeorgia runoffs. This lays forward a path for a more progressive agenda, but only modestly so, given the razor thin control over theSenate and net loss of seats in the House. The net impact on earnings in 2021 will be positive, as any corporate tax increases willoccur later in the year, while the new Administration will introduce further stimulus early in the year. The full impact of any corporatetax hikes will be felt more on 2022 earnings.

CHART 18: CYCLICAL SECTORS TO DRIVE 2021 EARNINGS GROWTH

Cons

ensu

s EPS

Gro

wth

Exp

ecta

tions

Source: TD Securities, Goldman Sachs Global Research

63%

14%

40%

7%

0%

10%

20%

30%

40%

50%

60%

70%

S&P/TSX Composite S&P 500

Cyclical SectorsDefensive Sectors

Corporate Credit

• In this low-yielding environment, investors everywhere are looking for asafer place to find some marginal returns. Thus, a yield pickup of about 150bps over sovereign bonds looks pretty compelling. In addition, an earlycycle environment with rising earnings, and companies that on the wholehave strong balance sheets suggests that corporate credit looks attractive.The liquidity backdrop is also favourable. The ECB and Bank of Japan havelong been supporters of higher risk assets, but the Fed and BoC have joinedthis past year by rolling out programs that support corporate investmentgrade and provincial bonds in the event of a sharp deterioration in marketliquidity and funding. However, the overall level of credit spreads doeslook like it is close to fully reflecting our forecasted levels.

• Moving forward, our credit strategy will continue to be focused on higher quality companies, but with some yield advantage further down the capital structure. Canadian Bank Alternative Tier 1 debt is an examplewhere marginal added risk is limited relative to its spread gain. Telecom issuers are also favoured for the structural demands for bothwork and entertainment that make our devices and home connectivity indispensable. The risks around credit remain low overall, sowe maintain an overweight in fixed income portfolios, for now.

CHART 19: CORPORATE CREDIT STILL LOOKS ATTRACTIVE

Basis

Poi

nts

Source: FTSE Global Debt Capital Markets Inc., Connor, Clark & Lunn Investment Management Ltd.

FTSE Canada Corporate IG Spread

50

100

150

200

250

300

350

400

450

2004 2006 2008 2010 2012 2014 2016 2018 2020


Duration and Yield Curve

• Canada’s nominal and real yields dropped last year alongside those inthe rest of the world; policy rates were cut 150 bps in March alone. Ourshort-term interest rates will remain anchored at zero for at least two fullyears. However, the improvement in the macro environment will start tocompel central banks to moderate their quantitative easing purchasesbefore signaling interest rates need to rise. Moreover, a strong cyclicalbackdrop will see longer-term rates drift higher, particularly as inflationconcerns creep into the market.

• Interest rates are likely to climb from here. Nonetheless, financial repressionlimits how high rates can go. We believe rates are in an uptrend from here,but at a gentle slope. The mass of negative yielding global debt also actsas an anchor to Canadian yields surging too far. As a result, duration inbond portfolios will be traded tactically, with a bias to the shorter side.The yield curve has room to steepen, with any shift in yields likely to beexpressed at the longer-end of the curve only. Typically, yield curves cansteepen 200 bps or more out of a recession. That is not likely this year.

• One additional area in which we continue to see value and a good hedge against inflation are in Real Return Bonds (RRBs) in Canada.The 30-year break-even inflation rates are closing the year at about 1.5%, and some 50 bps below their US counterparts, despitesupport from the BoC.

CHART 20: ROOM FOR CONTINUED STEEPENING

Perc

ent

Source: Bank of Canada, Macrobond, Connor, Clark & Lunn Investment Management Ltd.

10Y-2Y Yield Curve

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

1995 2000 2005 2010 2015 2020

Table 3: Scorecard (Macro Inputs)

Economy Monetary Inflation Valuation Technicals Total

US + + + N - +

Canada + + + N + +

Europe + + + N/A N +

China/EM N N + N/A N/A +

Total + + + N N +

+ Positive; – Negative; N Neutral; N/A Not applicable


SUMMARYOur 2021 forecast is optimistic as we expect to see a pervasive reversal of much of what went wrong in 2020. We will see the rollout of COVID-19 vaccines combat the effects of the virus; economies will gradually reopen from the isolating lockdowns; countries, governments, businesses and households will benefit from an economic recovery after the deep recession; and equity market leadership will broaden as investors rotate towards companies that will benefit from the coming inflationary landscape. It is likely to be a year of solid growth, sharp earnings rebound, stable valuations, US equity underperformance vs. Canadian and global markets and pressure on yield curves to steepen modestly. The US is divided but will look to unite at home and abroad. China will moderate and look for ways to become independent of the US. Europe may see a period of growth having now laid in the fiscal brick of the foundation that builds the common currency. The secular themes continue to shift towards a pro-inflation outlook, though the debt supercycle remains an ever-present and ever-growing concern. We have also learned an important lesson, that central banks and fiscal policymakers have demonstrated very little tolerance for shocks and do have the firepower to avoid a financial and banking crisis. For now, as we move to put the current virus-related hardships behind us, the economic outlook for the year ahead is bright. We remain optimistic for higher equity and credit markets, a rebound in early-cycle stocks, a weaker US dollar, and strengthening commodity prices.

This report may contain information obtained from third parties including: Merrill Lynch, Pierce, Fenner & Smith Incorporated (BofAML), S&P Global Ratings, and MSCI.

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