Global equity markets had a good start to the year. The underlying trends of gradually rising stock prices continued, and breadth continued to improve – significantly so since about mid-February when interest rates in the US and globally started to increase quickly. As a result, global bonds have not had a good start to the year. The Canadian Aggregate Bond Index fell 5.95% and the Global Ex US Ag Bond indices fell 2.6%. US Investment Grade bonds fell 3.2% in the quarter. Worst of all, the FTSE Canada LT All Governments Bond index fell 11.4%.
Equity Markets held their own with varied performance across sectors, countries, and regions as breadth improved. However, this was not a quarter in which the market tide floated all boats. Last year’s winners, or more broadly, the stay-at-home and momentum stocks of 2020 performed poorly as economic conditions continued to improve on the back of an improving outlook for vaccine rollouts. As was witnessed in Q4 2020, value continued to perform well with high growth or popular momentum stocks giving up considerable gains. The Canadian markets performed well with Canada up 7.3% for the quarter. Meanwhile, the S&P500, Japanese Nikkei and Europe were mixed, returning 4.4%, -0.55%, and 3.5% respectively. Overall, International or EAFE markets were up 2.7%. Emerging markets were up 1.9% after a large sell off in China late in the quarter. Small Cap issues significantly outperformed in the quarter on the back of stimulus hopes with the Russell 2000 returning 10.2%. Its outperformance thus far in 2021 is a function of monetary and fiscal stimulus and most importantly, the changing leadership.
As discussed at length in our year-end note, rising inflation expectations, and a subsequent increase in bond yields this year will have a major impact on markets and will likely result in a change of leadership in global equities.
Over the longer term, we believe that a normalization of interest rates will be healthy for the global economy. We have been living in a world with abnormally low interest rates and extraordinary monetary policy for more than 10 years since the GFC. The longer the normalization process takes to occur the greater the risk of disruption. Further, the pace at which this normalization takes place will determine the level of disruption. We hope slow and steady wins the day in the rates world, but the last quarter has shown that markets can move very quickly and when they do, regime determination is very important. We remain vigilant to the risk of inflation and disruption in the markets. The question remains, will the normalization process be normal?
We remain mindful of high valuations, interest rate risks and bubble-like behaviour in the markets. Some of the excesses seen earlier this year and late last year have diminished but, there is still plenty of fantasy priced into valuations. As in past market excesses, the process of transition can last many months and, in some cases, years. We expect solid returns in the year ahead, but stress that the stocks leading this process may not be the mega cap tech stocks of the past few years and, more importantly for balanced investors, the contribution from fixed income or credit positions will be de minimis or in many cases negative. Equity portfolio construction has never been more important than in today’s fast changing interest rate environment.