Accelerating the Road to Recovery

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Dan Barclay:

Good afternoon. Thanks for joining us today live. As part of our Road to Recovery Series of BMO. Today's discussion is focused on the acceleration of the recovery. In North America economies are tracking toward a robust recovery. And we are moving forward with renewed confidence and optimism for the future. We have a widespread vaccination, the reopening of restaurants, hotels, and entertainment. The resumption of travel, I myself was in Vancouver this weekend. But there are some potential clouds. The Canadian economic outlook remains highly dependent on the pace of vaccinations, and the uncertainty about the various. Monetary and fiscal stimulus are expected to provide ongoing support to the economy. While households are expected to ramp up spending, as restrictions are lifted and boosted by sizable accumulated savings.

Dan Barclay:

The US has weathered the pandemic better than most advanced countries, and the US economy could grow at the fastest rate in nearly four decades. From a global market standpoint, we're seeing some of the strongest, most robust activity in mergers and acquisitions, sustainable finance, debt capital markets, and equities. There's no doubt the world will continue involve. And global development will advance in different sectors with different focuses than pre-pandemic. Today's discussion tracks closely to the reopening of the US, Canada border. A symbolic event that speaks to the economies of both countries that goes beyond imports, and exports, and cross border trade.

Dan Barclay:

Today's LinkedIn Live event, we've gathered some of our leading experts. To take a bit of a deep dive in what the reopening means for the economic future of both countries and for the world. Our guests for today are Brian Belski Belski, Chief Investment Strategist, Margaret Kerins, Head of FICC Strategy, and Michael Gregory, Deputy Chief Economist. So how close are we to the new normal? My first question, let's talk about the future growth forecast and outlook. Why don't we start by establishing our expectations for the economic rebound in the United States, in Canada, and more generally, the world. Michael, why don't we start with you?

Michael Gregory:

Sure thing. Well, thanks Dan. Well, we're looking for a real GDP growth to be six and a half percent this year in the United States, 6% in Canada, roughly 6% in the global economy. And both Canada and United States to grow around 4%, four and a half percent for next year. We do think that the spring and summer will reflect the high watermark for economic performance. And things will probably slow a little bit from this. The very strong activity we're going to see during that period. Well, why? Well, because we know that some of the pandemic relief measures are going to end. Some of the pent up demand is going to get satiated, and higher inflation in fact is eroding purchasing power.

Michael Gregory:

So, we do think that growth is going to be a little bit slower, as the rest of the year unfolds and into the next year. But the key thing, growth rates are still bearing very strong historically. And well above potential. And you move to some of the points why that's going to be the case. Fiscal policy is still positive for growth. Even in the United States, we're working through that bi-partisan infrastructure. And in Canada with the recent federal budget had a $100 billion of new stimulus. Although, the Bank of Canada is started to reign in, it's chewy with tapering. And the Federal will probably be there, in the not too distant future. Both Central Banks, a monetary policy is still a net accommodative.

Michael Gregory:

But perhaps the greatest, I think support for the economy going forward, is the fact that you mentioned, Dan those savings. Well, we have a lot of liquidity, gobs that in fact, that's parked in deposit accounts, both sides of the border. And you compare it to where the pre-pandemic trend was, and get the figures from May. You're looking at around $3.4 trillion of those deposits. That's a slightly more than 15% of GDP, that's in the United States. And of course in Canada, we roughly have around $250 billion of those mostly deposits.

Michael Gregory:

And then that comes in around for more than 10% of GDP. And that's just money that's sitting there waiting. It's itching to the spent and invested. Now it's true that, the risk presented by the rising COVID cases, and the variants are problematic. But Canada and United States are both highly vaccinated countries. We doubt we'll see an increase in a significant [inaudible 00:05:13], a major increase in restrictions. And the bottom line, if you think growth is going to be very strong.

Dan Barclay:

Micheal, that's great. I love the deposits, and I we’re going to go with that. Margaret, why don't we go to you. Where are we at with yields in the marketplace? And why are they trending lower? And how will the monetary policy, that Michael talked about shape or plan to rebound? A lot of the audience will be curious about when the Fed will start to raise rates? And what will the impact be for bonds versus equities? As we think about this period of cheap money.

Margaret Kerins:

Sure, thanks Dan. Those are some of the biggest questions that we've been fielding, over the past couple of weeks. Of course, 10-year yields are [crosstalk 00:05:56] points lower, since their recent highs of March. And it's really because of two things. The first is the extension in the pandemic timeline, with the Delta variants surging in a variety of places throughout the world. And especially places that might not have the same vaccination rates as we do here in North America. So the market is basically pricing this extended pandemic timeline.

Margaret Kerins:

The second big mover in 10-year yields, in particular. Has been that the market's pricing of the Fed has changed. Basically, it shifted from [crosstalk 00:06:40] what did the Fed to be behind the inflation curve to a Fed that is now discussing tapering. So the market's actually looking past tapering, and looking to the timeframe when they actually will increase interest rates. And that's really the next leg of the accommodation removal. So basically what happened is the market realized that the Fed will not sacrifice their inflation objective in order to meet the employment objective.

Margaret Kerins:

In terms of taper timeline, as Michael mentioned. We do expect tapering to occur later this year, or early next year. This is a patient Fed. You really do want to closely watch the impact of tapering on the markets and on the economy. They will message as they have in the past, that tapering is not on a preset course. And they'll maintain the flexibility to change course, if needed. Tapering should conclude in 2022. And re-hike should fall sometime in 2023.

Margaret Kerins:

However, as we all know, a two year forecast horizon is quite some time away. And many things can change during that time. But what I do know, is that this is a patient Fed. They will watch the evolution of the data. And they will want to see how the economy looks, as they remove some of the extraordinary accommodation. Now, one thing that I would know is Michael also mentioned this. That while they are tapering, they will still be extraordinarily accommodative. Buying 100s of billions in the first couple of months, of the tapering. And rates will still be at the zero bound.

Dan Barclay:

Yeah. So, yeah, it's been fun to watch the markets in the last few weeks, as they react to the current News. Brian, you've got a very strong view on the bullishness of equity markets. We're in the 11th year of a bull run. Are you still bullish?

Brian Belski:

Well, thanks Dan for having us. And great first question for us. And hello everyone on LinkedIn. Yes, the quick answer is, yes. Now, our 20 to 25 year bull market call originated in 2009, 2010. The second half of the bull market we've been clear about, started on March 23rd, 2020 last year, as the market reset. But we also have recently upped our forecast for 2021. For a price target of 4,500 and earnings target of 190 on the S&P 500, and 20,500, and earnings of 1180 on the S&P/TSX. Principally because, we continue to have faith in fundamentals. And that puts us overweight in both countries, by the way of financials consumer discretionary, and materials, and industrials, over the next three to five years. If anybody can make a three to five year call. We should try to, our favorite sectors are technology, communication services, and discretionary. Now that's point number one.

Brian Belski:

Point number two would be the market is transitioning, Dan. We've been so momentum driven really since 2018. And if we see as earnings continue to go up, that the market is returning more to a fundamentally driven, more earnings driven market. And I think that's very good and builds credibility for both countries, in terms of Canada, United States. Which brings me to point number three. And I think this is really important, Dan. That the stock market is a market of stocks. And I believe that too much focus has been on macro and quantitative measures, the last 20 years. In terms of investing and building portfolios.

Brian Belski:

We've taken our eye off the ball, with respect to; how to pick companies, how to look at operating performance, what balance sheets mean? What services mean? What cashflow means? And we continue to believe that as Margaret and Michael set the table with respective accommodative stimulus. What are we doing with that money? And with that money, we're buying the best assets in the world. And I think the best assets in the world are US and Canadian equities. And so I believe that stock-picking in bottoms-up investing, with respect to portfolios, and overall active investing, is going to be a theme for the next 10 years. And that's why it's going to be so important to have great fundamental research, and really stick with your process and your discipline.

Dan Barclay:

What I love is your bull forever.

Brian Belski:

Oh, will be there [crosstalk 00:10:55] at the right time, Dan.

Dan Barclay:

A reminder to the audience. This is LinkedIn Live. We'd love to get some questions for you for our panelists. What are the hot topics in the last few weeks has been around inflation? And are we headed into a big up cycle in terms of renewed inflation? Or is it really temporary as we come out of the pandemic? Michael, perhaps first with you. How do you feel about inflation? What do you think you're looking for? And what do you think the impact is going to be on economic recovery?

Michael Gregory:

Thanks Dan. Well, let's face it. What we know why we've seen some shockingly high inflation rates on both sides of the border, very recently. We know the narrative around that, base effects. All the reopenings is caused a rapid return to pre-pandemic pricing. And these things are temporary. The one that seems to have a little bit potentially more longevity, is the fact we've got these supply bottlenecks that are occurring alongside, still very robust demand.

Michael Gregory:

Now, historically these kinds of demand and supply shocks, tend to Peter out among themselves. Eventually demand gets satiated, and higher inflation itself, it tends to be a drag on spending. Meanwhile, these bottlenecks get that remedy, that the canal is eventually open again. And the higher price themselves, in some cases signal more supply. So these things tend to right themselves. So we're not looking for a persistent inflation problem. Whichever said they're only have to serve that compensating wage gains. Which tend to propagate that. There are some pockets of wage inflation. But not something on a broad base nature across the both economies.

Michael Gregory:

That said, and I mentioned earlier about lots of liquidity sitting around, or park mostly in bank deposits. And we happen to think that that could act as a little bit of a driver of more persistent spending. And the ability of consumers and businesses to keep paying a higher prices for a little bit longer. And we all know, and as Margaret mentioned, a lot of the countries around the world don't have the vaccination rates we have in Canada and United States. And as a result, that's supply response as we go through this fourth wave, or we go through the variance in those countries, it may limit the ability of them to remedy the supply shortages.

Michael Gregory:

So the bottom line is I do think when the dust settles, we're probably going to have a little bit higher run rate for inflation, we did before. We think on both sides of the border, we're looking around two and a quarter, to two and a half percent range, for core inflation. Which is meaningfully higher than we had before. But quite frankly, exactly what the Central Banks are looking for. They're a little more willing, the Fed's official target is to have inflation moderately above 2% for a while. And the Bank of Canada has been emphasizing is one to 3% range, rather than it's 2% midpoint. So I do think we're going to get the inflation rates that we settled down to, that is exactly what the central banks want to see. And quite frankly, it sets the stage for rate hikes.

Michael Gregory:

Now, if we do get inflation running persistently higher for longer, that could in fact get the Central Banks to act a little more quickly. Which again, through the higher inflation itself, by eroding purchasing power over those rate hikes, coming a little bit sooner. Perhaps a bit more aggressively that could in fact undermine the recovery somewhat. But that's not our base case. We do think that the inflation environment still looks quite benign.

Dan Barclay:

Margaret how's that translating then into how the markets, or how our clients are thinking about bond deals, and how they're investing today?

Margaret Kerins:

Sure. Thanks, Dan. Well, as we know the market's pricing in and out the replacing trade, and that's been impacting yields. The main factor really to watch, is not what the market thinks of inflation. But how the Fed is characterizing inflation. And the sight continues to characterize inflation as transitory, and the market is pricing to that. So if we were to see the Fed move away from that characterization of inflation as transitory. That's where we're going to get the big market moves. And then the market pricing really will depend on why the Fed has changed their characterization.

Margaret Kerins:

If it's because growth is strong, the long-end will react a little differently. Than if it's because they have persistent inflation, and the slow growth, and slow employment recovery type of environment. Either way the front-end takes off, with the front-end, moving higher and the yield curve flattens. Just the degree of planning really depends on why the Fed has changed their characterization. However, this is not today's story. the Fed remains focused on supporting a solid and sustainable economic recovery. And we still have a long way to go with the job market. So we really just need simply, this needs to play out over time.

Dan Barclay:

And Brian, you believe inflation is not here to stay. I think you've been writing about that recently. What do you think that the implications are for your investing strategy?

Brian Belski:

Well, the inflation call that Michael and Margaret are making, is pretty much on board with respect to what we're seeing, come from a longer term perspective. But as Margaret points out, we're dealing with what the inflation numbers are telling us today. And I think the major point should be, I continue to believe that Mr. Paul's the smartest person in the room. And we don't need to outsmart him. So if he's saying that it's transitory, it's transitory. And so I take a look at how earnings Dan continued to go up fundamentals from companies, continue to improve. And in an environment with double digit earnings growth and low interest rates. Remember we did some of these calls in the first quarter, and we thought rates were going to 2%.

Brian Belski:

Well, a funny thing happened on the way to 2%. We're down around, in the 120s now. And so I think we're going to be at these levels with respect to valuations coming back in as earnings increase. And again, it's an exemplary opportunity for stocks. And lastly, I would say this, for longer-term investors looking for yield. I think the theme of cash distributions in the form of dividends and dividend growth, fits perfectly with the North American markets. Especially, given Canada's historical lineage to the UK. And how a Canadian companies have done a great job managing their cash in paying dividends, and payout ratios in the US are still at, or near all time lows, historically.

Brian Belski:

And they're increasing though in fascinating areas like technology, healthcare, but especially financial. So I think there's a real opportunity from the equity income side of things. As long as rates remain low. Remember Dan, since the great financial crisis, the average 10-year treasury is at about 210 basis points. And so we're still way below that, and the average 10-year treasury over the last 60 years is 5%. So we've got a long ways to go before we get back into any historical norm.

Dan Barclay:

That's great. We've got a bunch of questions coming in from the audience. So first off, let me say thank you and a reminder to all, if you'd like to pop a question in. That would be great. We've actually had a couple of questions talking about the exchange rates. The first was phrased around, if we had the amount of borrowing that we've had with the two governments, what does that mean for our long-term outlook for both the Canadian dollar and the US dollar? And then the second was, what's a medium term outlook Canadian dollars? Why do we try and do those two. Maybe I'll start with you Michael, and then go to you Margaret.

Michael Gregory:

Sure thing. Well, I mean, honestly, we had tremendous amount of borrowing by both governments. And it is one narrative we don't hear at all is reigning us in any time soon, regardless of political Stripe. So I do think that at some point over the medium term as and chair Powell has implored. This is not a sustainable situation, but don't do anything about it now, let's wait until the economy is stronger, and the recovery it has a strong footing, before we start reign that in. So the bottom line is from a medium term growth perspective. Paying the bills, bringing the fiscal shift back, riding that ship, is going to be a bit of headwind over medium term growth prospects.

Michael Gregory:

It means, higher taxes [inaudible 00:19:18] have been the case, lower spending might've been the case. Therefore, subsequently slower growth. And now the implications for the exchange rate. Obviously, depending on what ultimately is the response from a monetary policy, in dealing with those medium term growth prospects. Which are a little more restrained than they otherwise would be. I mean, that's altering in the drive that currency in terms of the Canadian dollar itself.

Michael Gregory:

And we happen to think that with the global recovery continuing, the North American recovery continuing, commodity prices continuing to drift stronger that. We were still looking for the Canadian dollar to strengthen over time, and to see a currency in this is a low 80 range, 82, 83 US cents within the next year or two. I think that's, again, that remains in the cards again, in an environment where the Bank of Canada is a little bit faster than the Fed, perhaps. In terms of a normalizing policy, but more importantly a backdrop, a pretty solid global commodity markets.

Dan Barclay:

Nice try, Micheal [crosstalk 00:20:29]. Let's go. Five-year exchange rate, come on! You danced all the way through that without a number, come on!

Michael Gregory:

If I had to do a five-year exchange rate?

Dan Barclay:

Yeah.

Michael Gregory:

I'll call it an 83 cents.

Dan Barclay:

Beautiful! Can't let you off the hook. Margaret apologies for interrupting.

Margaret Kerins:

Oh, no. I think the only thing that I would add in, Michael nailed it on that question, of course. And the only thing that I would add, is we're clearly watching the Bank of Canada's tolerance for a higher Canadian dollar. Especially, in the backdrop of the commodity market. So that's just one factor that really could impact the exchange rate.

Dan Barclay:

That's great! Turning to the audience. We had a great question, which is what position are financial stocks in right now? And considering inflation and potentially the increasing interest rates. How do we think about the evaluation of the financial sector? So Brian, it seems like a lay-up right to you.

Brian Belski:

Oh, I love this question. As you know, we've loved financials for a long time. And what's interesting, Dan about what's happened this year. Is that at one point, the regional banks in the United States were trading at a premium to the Money Center Banks, and clearly where it was going on in Canada. And as if rates have actually gone lower, net interest margin for the regional banks suffer. That's why we continue to like, what we like to call scalable type of assets in financials. Money Center Banks in the United States, Canadian banks in particular. These multi-divisional assets that have the Wealth Management Practice, Commercial Bank Practices, Capital Markets Practices. That they can go with the ebbs and flows, with respect to a quarterly basis in terms of earnings in growth.

Brian Belski:

But I think also the brokers and asset managers in the United States are great assets as well. So I continue to believe based on my conversations with clients around the world. That our clients on the institutional side are massively under owning a financials. Especially, some of the Canadian banks here. Our own bank, BMO, TD, and RBC with a cross border relationship to the United States, I think are going to be the best position to assets. But then also JP Morgan, Morgan Stanley Bank of America, I think are great assets, Goldman Sachs, BlackRock that I think investors are missing.

Brian Belski:

And then further to my point before as well, Dan, I think these companies are becoming juggernauts with respect to dividend growth. And remember a year ago we were worried that the Canadian banks might, could be able to pay their dividends. Which was all feared laid in. And we wrote a lot about it a year ago, and warn people that the banks were over reserving. And now with that over reserving, they're paying out these great dividends. That's going to continue. So we think that they're great longer-term total return vehicles.

Dan Barclay:

That's great. Good question here from the group, on labor markets. And what do we think the forward labor employment looks Canada and in the US? Michael, maybe start with you.

Michael Gregory:

Yeah, sure thing. I mean, the recovery in labor markets is going to lag the recovery in the broader economy. In fact, we think GDP has already fully recovered in the US and the second quarter, it'll be the third quarter in Canada. But it's going to be towards the end of this year that in Canada, we get those jobs back, in sometime say next summer for the US. So it could take a little bit longer to get a full recovery in the labor markets.

Michael Gregory:

And, but there are some issues that are beginning to appear within that. And what we see is labor force participation rates, have yet to return to the levels that we had before the pandemic. A little more close to that level in Canada, but still far from it in the US. We know many states are dropped out of some of the support programs from the Federal Government Labor Support Programs, earlier to try and entice more individuals to re-engage in the workforce. And it's still early to see whether that has been successful or not. Hence that it's starting to work in some of those key states. But again, we'll have to see what happens here.

Michael Gregory:

But the other issue too, is how much work changes because of the pandemic [inaudible 00:24:41]. Probably I'll steal a chunk of activity, in that work from home mode. That's going to be a permanent fixture on the landscape. And also, the persistent problems we're having. And before the pandemic, we already had a cheap labor problems in many segments of the US. Particularly, the manufacturing sector. And those things are going to materialize again.

Michael Gregory:

And perhaps the number of sectors having those problems will expand. Another reason why many people in the food service, accommodation area are having problems finding workers. Those workers have gone elsewhere. Well, this is just that automation has to be in a very important role to play going forward in dealing with some of these labor shortages. But we think we'll be back down to pre-pandemic levels of the unemployment rate by the end of next year. And of course, again, setting the stage for Central Banks to begin normalizing policy.

Dan Barclay:

That's a great one. Margaret, we had a question for you. Which is, what's the impact of inflation on the Credit Markets and how do you feel about that [crosstalk 00:25:42]?

Margaret Kerins:

Sure. So, obviously runaway inflation is probably the biggest threat to credit spread. Credit spreads are still very near, post a great financial crisis tights, even after backing up a bit last week. And a runaway type of inflation environment is just very negative. That's not our base case. We actually think that credit spreads will reach new great financial crisis lows later on this year, in the next couple of months. So we're very constructive on credit spreads. But definitely the biggest risk is the runaway inflation type environment, but not in the cards for us.

Dan Barclay:

That's great! Very clear. We'll go with our last question from the audience. And I think this is what I'll call our diamond hands question. Brian, would you view a five to 10% pullback or correction in the market as a buying opportunity for both hands? If so, what were the three sectors that are most on your shopping list?

Brian Belski:

I would say both hands and both feet, Dan. I would say financials technology in consumer discretionary-wide, because we're really good at buying stuff in both Canada and the United States. So a consumer is going to run in technology, I think is going to be the leading sector for the next three to five years.

Dan Barclay:

Well, let's do a really quick wrap up. I have one question for each of you, rapid fire. We'll go Margaret, Michael, then Brian. What are your reasons for optimism as we look forward?

Margaret Kerins:

Sure. I think the biggest reason for optimism is that rates are still low, which is very cumulative to the economy, and to the Housing Market. So we're very positive, a couple of months ago the market was tightening for the Fed. And the market's no longer tightening for the Fed. So we will be in this accommodative mode for some time. And that is very supportive to the recovery.

Dan Barclay:

Micheal.

Michael Gregory:

Yeah. Perhaps I'll yeah, I'll jump in there. I mean, in addition to this persistence accommodation. Even when we're less accommodative, we're still going to be accommodative. I think it's resiliency, you've really got to think about. I know we've had three waves of a pandemic, and we've bounced back each time. And sometimes very quickly. So I do think is that resiliency, how we've changed things. We've done things that normally take months and months, and years and years to do. We've done it in days and weeks, in terms of changing fundamentally operations, and how we do business. So it's that resiliency, I think that's particularly encouraging. So no matter what the future has in store for us, on the various other risks that are out there to the outlook. I do think that what we've shown is we are resilient economies, and that is one of our greatest strengths.

Dan Barclay:

I realize that, go ahead [crosstalk 00:28:36]-

Brian Belski:

I'll finish up by saying, yeah, I think Michael is spot on. I don't think we've given ourselves enough slack from a social perspective, personal perspective, of a business perspective. I think we're doing great through all of this. And the fundamental backdrop of stocks in both Canada, the United States are fantastic. But then lastly, this talk of a five to 10% correction, a 20% correction. Nobody can time the market. The markets are going to be a higher a year from now. And I think just the more people talk about corrections, Dan, the more that they do not happen. So we want to stress to people to continue on with your process, stay invested, and keep being a fundamental investor.

Dan Barclay:

That's a great Roundup. And thank you. Thanks to Michael, Margaret, and Brian. Great insights for us and the audience. To the audience that dialed in for LinkedIn Live, great that you share a time with us. We hope you enjoyed the messages that we had today. If you have any questions, please reach out to your BMO Relation Manager, or you can dial in to bmocm.com, to get copies of our past podcasts, and other materials as we focus on the market. I appreciate you joining us today. Thank you very much. And we look forward to connecting soon. Have a great one.

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