Stock Market Updates from 5i Research - April 15, 2021

Barkha Rani Apr 15, 2021

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Report Updates

We have updated reports on Andrew Peller (ADW.a) and CCL Industries (CCL). We have maintained the ratings of both names. Both have been relatively slower growth names, but have managed the pandemic quite well and are well-positioned going forward. One has adapted with an e-commerce platform and will benefit from a return to social gatherings and the other we expect to benefit from a general economic recovery due to it is diversified product portfolio. 

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Market Update

Over the last two weeks, economic events have been relatively mild by today's standards, which arguably is a good thing for the markets. North American indices are all up on signs of economic recovery including positive employment numbers, more manufacturing activity, an infrastructure bill being pushed in the US, and central banks continue to show support by committing to low-interest rates. Of course, the rate of vaccinations has also been positive for markets with the expectation of a true reopening of the economy drawing nearer. Some pressure has been lifted off of technology and growth stocks as markets appear to have digested spikes in treasury yields that began in February and subsequent moves in interest rates having less of an effect on the market. This is reflected in the Nasdaq which is up 7% since the beginning of April compared to the S&P 500 and TSX which were up about 3-4%.

While vaccinations and signs of economic recovery have been good for stocks, over the last month, markets have moved on to the next worry of inflation. With households having more to spend from pandemic relief payments and the reopening of economies is expected to improve as more people get vaccinated, it makes sense to expect higher inflation in the near term. So, why do markets worry about higher inflation? 

Higher inflation can result in higher input costs for companies and higher prices for consumers who may spend less as a result leading to lower corporate profits. Perhaps what scares markets most about higher inflation is that it can lead to central banks responding with higher interest rates, which has a more direct impact on stock valuations and cost of capital (loans, etc.). However, long-term fundamental investors should be less concerned with short-term market fluctuations and increases in interest rates tend to have more of a short-term effect on equities. Let's take a look at how the S&P500 and TSX have performed during different inflationary periods: 

As we can see from the chart above, there does not seem to be a direct correlation between the performance of both the S&P500 and TSX and one-year changes in inflation. Overall markets have done well and even sometimes performed well in years that had increases in inflation. This may suggest that corporate profits can benefit at just the right amount of inflation if consumers are able to absorb moderate price increases. The periods where inflation had a pronounced negative impact on markets have consistently been when we saw sharp spikes in inflation rather than moderate inflation. These spikes in inflation are often followed by a recession, then a recovery in both inflation and stocks as the market recovers. This is clearly seen in the 2008 recession.

Fast forward to 2021 and beyond, certainly sharp inflation is possible given the magnitude of the COVID-19 recession and the potential for a rapid economic recovery. However, consumers may be more resilient than expected with more savings and cash to spend. Finally, we are less concerned about the consequences of high inflation (within reason) right after a recession as this has been a part of the economic recovery process in the past. 

Best wishes for your investing!



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