On the Money


Navigating the year ahead

January 19, 2021

Myles Zyblock, Chief Investment Strategist, discusses his outlook for markets and economies in 2021, but with a lot of consideration given to the impacts of an unprecedented 2020 on both.


Mark Brisley
Managing Director

Myles Zyblock
Chief Investment Strategist


Mark Brisley: You're tuning in to On the Money with Dynamic Funds, a podcast series that delivers access to some of the industry's most experienced active managers and thought leaders. We're sitting down to ask them the pertinent questions, to find out their insights on the market environment and navigating the investment landscape.

Welcome to another edition of On the Money. I'm Mark Brisley, head of Dynamic Funds. I am joined once again by Myles Zyblock, Chief Investment Strategist here at Dynamic, but also a well-recognized strategist across North America, regarded for his investment insights that blend the tools of finance, and psychology in order to capture major inflection points in financial markets.

Myles provides top-down strategic investment ideas and inputs for our portfolio managers and analysts. In addition, his investment views are shared even more broadly, via regularly written research reports and his regular appearances on financial media platforms across Canada and the US.

We're framing our conversation today around an outlook for markets and economies in 2021, but with consideration given to the impacts that an unprecedented 2020 have had on both. We look back on a year that ended up being bookended by two bull markets, seemingly both quite different in nature, with a not so significant bear market in the middle.

The world has seen this before, but perhaps what was most curious was the speed of the market's recovery and the disconnect between that rebound and the overall perception of broader economic health and stability. Myles, I look forward to diving right in here. I'm going to get started with the obvious fact that we ended off a memorable year in the markets and in the world in general, what surprised you most about the past year?

Myles Zyblock: Well, Mark, thanks again for having me on the program. It's always good to chat with you. There were so many things, I was amazed by, for example, the speed and depth of the global economic collapse, the intensity of the equity bear market, and the subsequent and what can only be described as really epic price rebound. What's most remarkable with the last 12 months is that it provided me with I guess, a living example of our adaptability to extreme and novel situations.

We figured out ways to move forward even as schools and businesses were closed, travel was stopped, life, in general, was flipped upside down. Many of us embraced technology, and we started to wear masks, social distanced, global policymakers were working double-time to support the private sector as it attempted to navigate the health crisis.

With a lot of efforts and human ingenuity, we were able to bring what appears to be highly effective vaccines to the market in record time, and all of this has taken a lot of collaboration and cooperation on the part of people and businesses, and governments.

We seem to focus on the negatives, and there are plenty of those to focus on. I really was inspired by many of the things I'd witnessed over the past year. We're still not out of the woods, and many families and businesses are really struggling, but I think we're working our way towards a sustainable solution, or return to some form of economic normality. I guess you could say, we're finally seeing some light at the end of the tunnel.

Mark Brisley: Yes, the scope of the pandemic and the impact of COVID-19 was just so broad in so many ways, but if we think about it economically, do you think in your view that COVID-19 has reshaped economies?

Myles Zyblock: It is. The biggest changes I think are occurring around the home. Entertainment, leisure, eating, shopping, and working are largely being done from the home or say in a neighborhood proximity of the home. The pandemic has effectively localized a large share of our daily economic life. Technology has been the gateway to this new way of life, the accelerated and broad-based adoption of technology will probably generate some lasting impacts on behavior.

It's not to say that we're never going to shop in malls again, or that Netflix will completely replace movie theaters or office space is going to follow the dodo bird. It's going to take some time following widespread vaccinations to fully gauge the differences between what appear to be transitory and would also appear to be lasting changes. Needless to say, I think our economic future will probably look quite different from its pre-pandemic past.

Mark Brisley: So much discussion looking at 2020 in review and even during 2020 and that conversation is going to continue in 2021 was around equity and bond market returns but also the connection to this low-interest-rate environment we find ourselves in or the thought that it's a lower for longer scenario we're in. What do you think all this means for future returns in the market?

Myles Zyblock: You hit the nail on the head, interest rates are really low, incredibly low. The 10-year US bond yield, it sits at about 1%, which is basically the lowest level we've ever seen. That goes back 150 years. Keep in mind over that history, there's been at least two major economic depressions, and several very large financial crises, and yet bond yields today are still lower than any other time in history.

The odd thing is that those yields are relatively attractive, those US yields are attractive when we broaden our lens to include the remainder of the global bond market, about 27% of today's publicly traded bonds across the world carry a negative yield to maturity. That's simply stunning.

You can't find a single government bond in Germany all the way out to 30 years, that has a positive yield. Just before coming on and talking with you, I checked in the 30 year German government bond now yields -0.15%. I think these ultra-low yields or global yields are in part at least explained by some powerful disinflationary forces like aging demographics and globalization.

There's no question in my mind that central banks have also played a big role in suppressing bond yields. They've basically nailed their policy-set interest rates to the floor, and they've been buying trillions of dollars of bonds, that's known as quantitative easing from the secondary markets. These are large price-sensitive buyers, and they're probably holding yields at lower levels than otherwise would be the case.

Just to understand the scale of their bond-buying programs, I'll give you a made at home example. The Bank of Canada, our central bank, now owns 45% of the outstanding stock of government of Canada debt. For every dollar owed by the government, 45 cents is now owed to the Bank of Canada.

The story is similar in the US, Japan, and across much of Europe. The most direct impact all this has had is on the government bond market. Like I said, bond yields are low, and this also means that future returns for those bonds are likely to be low.

If I buy a 10-year government bond yielding 1% today, I know that I'm going to get close to a 1% annualized return over the life of the bond. What's the yield scarcity done, I guess, is it's encouraged investors to reach for yield, to chase yield. The ripple effects have spread outward from the government markets.

I calculate that about 12% of the entire stock of global corporate bonds now carry a negative yield or a yield below 0%. This is filtered into higher-yielding bonds, and even into the equity market. Low risk-free rates have helped push valuations higher right across the asset class spectrum, and so you have higher valuations in both equities and bonds. That probably means we need to temper our long term optimism for these traditional asset classes.

It's not to say that we can improve the odds of better returns. Let me give you the equity market as an example, the lion's share of today's equity valuation risk is really concentrated in the largest 50 stocks. If you control your exposure to many of these mega-cap names, that can help lower the valuation risk in an equity portfolio by between 25 and upwards of 50%.

Said differently, selective participation in the equity market can offer investors an effective workaround to these potential valuation challenges. I think the same idea can be applied to many of the other asset markets. The bottom line really is say in the next 10 years, they're probably not going to be as fruitful for investors as the past 10 years, given today's starting point.

Mark Brisley: With that in mind, and you're talking about asset classes in those comments, what are your thoughts on economic growth prospects when we think about regions, and maybe I'll start with the first two that were most impacted by the pandemic being North America and Europe, but then also looking a little more broadly out towards regions like emerging markets?

Myles Zyblock: Well, I mean, if you take a step back and you look at the world economy, I really do believe that it's entered the early stages of an economic recovery following one of the deepest downturns for sure in the past 100 years. After declining by about 4.5% in 2020, I think world GDP has a good chance of expanding by more than 5% in 2021, so a really healthy rebound. Corporations and individuals have made impressive adjustments in order to continue moving forward in what's really been incredibly challenging environment. Governments and central banks have also been crucial, like I've discussed, they've been a crucial part of this recovery story. They've added a combined $30 trillion. That's equivalent to about one-third of world GDP. They've added $30 trillion in emergency support.

Then we have the vaccination campaign, and that should soon help to start unlocking about a year's worth of pent up demand and set the stage for a sustained recovery into 2022. If you were to summarize, I think that we're on the cusp of a global recovery, I think the recovery is likely to be broad-based. I think pretty much all major regions in the world are going to grow at a much faster pace this year definitely than last year. I'm pretty optimistic on the economic outlook.

Mark Brisley: I know one of the questions that a lot of heads of central banks are getting and government officials is the question around inflation and whether or not this recovery is considered to be sustainable enough for the conversation about inflation to change. Do we see any inflation scenarios over the coming year?

Myles Zyblock: Things like aging populations, particularly in the developed world, globalization, technological innovation, increased labor market flexibility, I think all of these have placed significant downward pressure on the inflation rate over the past 30 to 40 years. Typical inflation readings of like 5 or 6%, or even higher, throughout the 1970s and 1980s, have been replaced by rates, which are more commonly hovering under 2%.

This isn't to say that an inflation scare is impossible in the current environment. Economic recoveries, even during the last 15 to 20 years of low inflation, economic recoveries have usually been accompanied by accelerating rises in consumer prices. For example, after the 2000 recession, inflation rose by 1.8 percentage points before it peaked out at close to about 3% in 2006.

Inflation picked up the pace again, following the great financial crisis, from below 1% to about 2.5%. It seems likely that some upward pressure on inflation is going to surface as this recovery matures, labor and product markets are going to tighten. I think inflation in North America could increase from somewhere around 1.3-1.4% in 2020, last year, to maybe two to two and a quarter by the end of 2021.

I really do think it's difficult to expect much more than this. Like I said, those long-term disinflationary forces are likely to keep a relatively low ceiling over the inflation rate for several years to come. Again, maybe a little more inflation, but I don't think runaway inflation.

Mark Brisley: Another area we get a lot of questions, Myles, is around currency. My question for you today is specifically around your outlook for the Canadian dollar. When I think about that, I think the Canadian dollar closed in 2020 in year three or high versus the US dollar, but what's your outlook for the Canadian dollar?

Myles Zyblock: You're right, the Canadian dollar, it's strengthened from about 70 cents to almost 80 cents since the first quarter of 2020. 9 or 10 month period that's a dime, and that's a big move in currencies. I don't think the timing of the move is a coincidence. Most of the riskier asset classes whether they're equity indexes, or commodities, or high yield corporate bonds, all bottomed late in the first quarter of last year before turning higher.

Global currency investors have generally viewed the Canadian dollar as a riskier or more cyclical currency, much like the Australian dollar and many of the emerging market currencies.

With global growth firming and commodity markets stabilizing, I think currency investors are leaving the relative safety of US dollars to the benefit of say, the Canadian dollar and other procyclical currencies.

Again, I view what's going on here is a gathering global economic recovery. I think the Canadian dollar is likely to trade on the side of further strength and we may even see it surpass 80 to 83 cents in the not too distant future. I am still of the view that cyclical currencies like the Canadian dollar have more room to appreciate in the coming quarters.

Mark Brisley: Since the last time you and I chatted, we now have certainty as to what's happening south of the border in terms of an administration or a new administration. We know that also the Democrats will control the House and the Senate. Can you talk a little bit about some of the proposals that the new administration, specifically President Biden is expected to put forward and what some of those implications are going to be for us from a Canadian looking at the US perspective?

Myles Zyblock: Biden has, if you look at all that he's written, he's set out a, what I consider to be a broad-based agenda, which he argues at least is a net benefit to middle and lower-income Americans. Some of the things he talked-- For example, tax rates are expected to increase for corporations. It's also expected to increase for individuals earning more than $400,000 a year, and that's the top 1% of income earners in America.

He's effectively turned himself into Robinhood, by taking from the rich and giving to the rest of the country. He's offering more generous tax credits for child care, elderly care, and first time home buyers. I think the largest areas of new spending, at least he's telling us are planned for education, that's almost $2 trillion of new spending there. Infrastructure, another $1.6 trillion of new spending, and that's what he assumes over a two-term period.

He believes he's going to hold on for the next eight years. In total, the Biden platform, at least from my lens is estimated to be raising about three and a half-trillion dollars in new tax revenue. While at the same time, they're increasing their spending by about five and a half-trillion dollars.

Assuming that the objectives are met, and that's a huge assumption, his plan going in it represents about a 1% boost to the US GDP per year, on average, over the life of his two-term presidency. What do we take away from that as Canadians I think is pretty basic, is that it's more spending, it's more stimulus, which means probably a little stronger US economy, a little stronger US consumer.

Given that the US consumer is pretty much one of the key engines of global growth that benefits everyone, both directly and indirectly. Again, people are focused on the Biden tax plans, but on net, he's injecting more stimulus into the economy than he is subtracting.

Mark Brisley: This next question might have been one that if I think back a year ago, would have been almost impossible to answer if we had been able to foresee what was about to happen. When I pose the question of what are some risks investors might not be paying enough attention to? How does that get answered today now knowing what we have gone through, what was possible and your outlook going forward. A second part of that would be are there parts of the market that you think are showing signs of exuberance, or over-exuberance, or potentially even signs of a bubble?

Myles Zyblock: Well, before we get into that, I want to say that I am fairly positive on the year ahead. Economic growth looks like it's improving, vaccination programs are ramping up, policy settings are likely to remain quite loose, and corporate earnings should advance in a meaningful way.

As money managers, we can't be blind to risk and still survive. On that front, there's a couple of risks that immediately come to mind for me, and to start, I'm not sure if people fully appreciate the concentration risk, which has built up in many of the world's equity benchmarks.

The top five stocks in the S&P 500 for example, now comprise about 20% of the entire market capitalization of the index. That's a higher share, than what we saw during the 2000 tech bubble. As I said earlier, many of these main cap stocks, they're not cheap.

They carry valuations that are 30 to 40% higher than the typical stock in the equity market and share their great companies with solid business models, but if something unexpectedly entered and materially changed their story, say like, I don't know, antitrust regulation, their stock prices could decline in a meaningful way and given their sheer size, this would probably also lead to a lot of downward pressure on the broad averages.

It's funny, I gave you the US example, but Canada is really in a similar boat. With the top five stocks in Canada for the TSX now comprising about 25% of Canadian equity, the total weight in the Canadian index. This concentration risk just isn't a made in the US phenomenon. It's going on in many different averages around the world.

Maybe another underappreciated risk, I think can be found in the bond benchmarks. I estimate that say, Barclays Global Aggregate Index. I estimate that that is a well-known bond benchmark. It's now 63% more sensitive to changes in interest rates today than it was, say, at the turn of the century.

Let me put some numbers around that. A one percentage point increase in interest rates today would generate about 7.5% loss in the value of the global bond benchMark Brisley:and say that compares to 4.5% loss for an equivalent change in interest rates back in 2000. The benchmarks have been increasingly stuffed with longer-dated bonds, with little to no-coupon, and that leaves them more susceptible over time to interest rate movements.

Given the risks that I just mentioned though, I think one of the related investment themes for the year ahead and probably beyond that is selectivity. What do I mean by that? I think you have to know exactly what you own and why you own it. It's just something to keep in mind given these situations we're seeing in a lot of the broad averages.

Mark Brisley: Well, Myles, thank you for that. It's always an insightful and fascinating discussion with you. I'm sure when we talk again, which won't be too long from now, that we're talking about even more positivity looking forward. Thanks for being here.

Myles Zyblock: Thanks, Mark. It's a pleasure being on the program.

Mark Brisley: Thank you to everyone for joining us on another edition of On the Money. As always, we believe the best access to financial advice is through a qualified financial advisor. On behalf of everybody at Dynamic Funds, we continue to wish you good health and safety. Thank you for joining us.

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