Q3 2021 Report by Jarislowsky Fraser SEPTEMBER 30 2021 Highlights Economic Review Supply chain disruptions, the Delta variant of COVID-19 and price bulges continue to be the main influences on the business cycle. Although the level of global economic activity is much more robust than last year, the pace has slowed in recent months, lending a slightly more positive tone to bond markets. After a strong start over the summer months, global equity markets were more muted by the end of the third quarter. Investment Outlook As we head into the final quarter of the year, markets remain focused on several factors: prospects for inflation and its ramifications on the markets China and its effect on global markets the ongoing pandemic with potential new waves from variants and the winter months. As it pertains to these key issues, our approach is to maintain a balanced approach and ensure our portfolios are resilient to a range of outcomes. Economic Review Our assessment of the economic environment is broken down into cyclical and secular horizons. Sometimes these are at odds with each other, such as when there is growth expansion on a secular horizon but yet we experience a recession within that period, which is what happened in 2020. The fact that the recovery is happening in stages is helpful in pacing the inflation swell. Of course, policy changes such as when the Federal Reserve will start reducing its bond purchases and whether President Biden’s new fiscal spending proposals will become reality are also near-term influences. In the latest quarter, the business cycle did not generate much that was new to investors. Supply chain disruptions, the Delta variant of COVID-19 and price bulges continue to be the main influences. In any case, we continue to expect modest upward pressure on interest rates in the near term. The more significant debate continues to be around the secular outlook for inflation and growth. Currently, the inflation proponents have the louder voice. Labour shortages, raw material shortages, exploding money supply, fiscal spending, addressing income inequality, diversity and climate change are just some of the factors that proponents of an impending inflation crisis are pointing to. What has become lost in the debate are some persistent and significant disinflationary influences, which we discuss below. We cannot ignore the rapid adoption of technological solutions to problems posed by the pandemic; as such, we are unlikely to fully return to our pre-pandemic ways of daily life, such as working and shopping. In effect, the pandemic has pushed forward investment in technology that competes with labour, and ultimately reduces the need for future hiring. Demographics on a global scale are still deflationary. Retiring baby boomers tend to spend more, but there is a massive contingent in China and other emerging markets, such as India, that is in peak saving years. Globalization is another deflationary influence that we have highlighted in the past and continues to influence the cost of goods and services. Even as globalization seemingly looks like its course has been reversed by some politicians, corporations are effectively looking to invest in future capacity in lower cost countries such as some African nations. As faster and cheaper connections are made, the world will continue to shrink. The trillions of dollars needed to shift to a greener economy are seen as potentially inflationary in the short-term; however, over the medium term, the required investment will likely result in a more efficient, less carbon intensive and more technologically advanced economy. We would actually be more worried about inflation if we did not address the climate issues facing us, as disruptive weather patterns point to increased economic costs. The secular inflation picture is a very complex issue and we have only scratched the surface here; however, there are enough countervailing influences to at least call into question the consensus view for a rising secular inflation scenario, even if the risks have risen. Bond Markets Bond markets saw modest gains as yields declined slightly; however, those gains were erased when yields increased in the last weeks of the quarter. Although the level of global economic activity is much more robust than last year, the pace has slowed in recent months, lending a slightly more positive tone to bond markets. Corporate bonds outperformed their government equivalents with demand remaining strong in this environment of low absolute yields. Investors are focused on the timing of the US Federal Reserve’s reduction in bond purchases. Unlike the Bank of Canada, which has cut the pace of purchases in half, the US Federal Reserve has been much more cautious in managing its reduction given the more significant implications for global risk markets. Investors believe the reduction in bond purchases is the first step in normalizing interest rates at higher levels. The process risks putting upward pressure on the USD, which in the past has led to instability in emerging markets. This potential instability would come at a time when many emerging markets are facing the negative impact of the pandemic. All this means that the withdrawal of easy monetary policy may be more difficult than expected. Equity Markets After a strong start over the summer months, global equity markets were more muted by the end of the third quarter. Regionally, China was among the weakest as a result of increased regulatory oversight on various sectors, notably education and technology, in addition to concerns over leverage levels in the property sector. Japan was one of the stronger markets globally as a result of improvement in the containment of the COVID-19 pandemic and an upcoming change in leadership with Prime Minister Suga announcing his intention to step down. The Canadian market was muted in the quarter; however, it still remains among the strongest on a year-to-date basis. US markets were also generally flat in the quarter, although performance was better than most other developed markets. From a sector standpoint, dispersion was generally fairly low. Financials remained firm as prospects for future rate increases were reaffirmed by central banks globally. Energy was also strong in many markets as demand recovered and some shortages were seen in select markets, notably Europe and Asia. Conversely, Materials were weaker on expectations for lower demand for many commodities from key consumer China. Consumer Discretionary shares were also a laggard in some markets as the Delta variant continued to prolong public health restrictions in many markets. Outlook As we head into the final quarter of the year, markets remain focused on several factors. First and foremost amongst those, as mentioned, is the prospects for inflation, and notably if it will prove transitory or more permanent. Should it trend toward the latter, this would have ramifications for equity markets as shorter duration equities, often characterized as more “value” oriented, would typically perform better in a rising rate environment. Stagflation, the prospect of rising inflation alongside muted economic activity, is also being considered as a possible future outcome. The second key debate centers around China, and notably if a single large property developer will have broader contagion effects to other sectors of the Chinese and global economy. Finally, while the ongoing fight against the COVID-19 virus has shown progress as vaccination rates have increased, the potential for new variants and additional waves through the winter months are further cause for concern. As it pertains to these key issues, our practice is to maintain a balanced approach and ensure our portfolios are resilient to a range of outcomes. Our focus on selecting industry-leading businesses on a bottom-up basis while maintaining a strict discipline on valuations through a long-term lens helps our portfolios be less volatile in a variety of economic environments. And in times of uncertainty and volatility, having done the analysis and due diligence on these businesses enables us to have confidence to take advantage of the opportunities that are sometimes provided by shorter-term sentiment in the marketplace. All returns are expressed in Canadian dollars unless otherwise indicated. Sources: TD Securities, S&P and Bloomberg. This document is prepared for general circulation to clients of Jarislowsky, Fraser Limited (JFL) and is provided for information purposes only, it is not intended to convey investment, legal, tax or individually tailored investment advice. All opinions and estimates contained in this report constitute JFL’s judgment as of the time of writing and are provided in good faith. All data, facts and opinions presented in this document may change without notification. This is not a solicitation for business. Past performance is not a guide to future performance. Future returns are not guaranteed. 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