We hope everyone remains healthy and well. We would like to answer some frequently asked questions (FAQ) on the current state of markets and the global economy. We culled responses from various economic strategists and portfolio managers. As usual, we are dealing with a mix of positive and negative data and ultimately, “the virus has the final say”.
For the visual learners, next week’s entry will compliment this week’s FAQ with charts of interest summarizing the first half of 2020.
Could you provide an overview of the last quarter? (Answer from Myles Zyblock, Chief Investment Strategist, Dynamic Funds)
Unprecedented action by policymakers and moderation in COVID-19 caseloads helped ease lockdowns and initiate the early phases of the eagerly anticipated re-opening of the economy. These developments were well received by the market and beaten up riskier asset classes soared.
All major asset classes finished Q2 in positive territory. Global equities rallied by just over 19%, with the U.S. stock market having its best quarter in decades. Emerging market bonds also rebounded to produce robust gains while corporate bonds outpaced government bonds, as they benefited from stronger risk appetite. Despite the rally in riskier assets, gold bullion remained resilient with a 12.9% rise in Q2.
With the increasing number of cases in the “sunshine states” do you expect to see another trough similar to March? (Answer from Dan Bastastic, Portfolio Manager, IA Clarington)
He believes there is enough liquidity and support in the market (2.5 years of money supply injected in 3 months) for us to not re-test the lows
- Does anticipate there will be continued volatility
- The money support is being used to bide our time until we have a vaccine (reports indicate this could be in a matter of months)
How is the current vaccine timeline impacting markets? (Answer from Myles Zyblock)
Equity markets were supported in early trading by the news that Moderna’s vaccine had induced neutralizing antibodies in its Phase I trial. The biggest beneficiaries from this news have been those companies and industries which have felt the greatest negative impact from the pandemic (i.e., “Viral Outbreak” stocks). These include industries such as airlines, cruise lines, hotels, brick-and-mortar retailers, resorts and restaurants. Those companies which investors have sought for safety, termed the “Stay at Home” stocks like grocery stores, food producers, technology providers and online retailers, were significantly lagging the broad benchmarks at the time of writing.
Weeks like this one offer a potential window into what is to come. The announcement of a viable vaccine seems like the catalyst needed to lift many deep value stocks out of their performance malaise. This rotation might also place a number of the year’s leaders into the backseat for a while. The difficult part is to know when this vaccine is likely to be found or go into production. Most experts still believe it is many months away. Yet with over 100 vaccines being developed and tested around the world, the likelihood of some form of eventual success seems fairly high.
What are your thoughts on growth prospects for major regions – North America, Europe, Emerging Markets? Any potential growth divergence expected given relative progress on COVID-19? (Answer from Myles Zyblock)
Official activity indicators for May and June started to snap back in response to epic global policy stimulus, moderating caseload growth, and reduced mobility restrictions. Europe, U.S. and Chinese auto sales were up by 41% collectively over the past two months. U.S. retail sales rebounded by 17.7% month-over-month based on the latest reading for May. A similar sharp bounce was recorded for U.K. retail spending. Employment has jumped higher, and much earlier, than expected in countries as diverse as the U.S. and Korea. Housing activity looks to be reviving. Leading activity indicators for manufacturing are coming off the bottom all around the world.
While 2020 is likely to encompass one of the deepest global recessions in history, with GDP probably down by 5% for the year, the incoming data also tells us that it might be among the shortest in duration. Of course, a lot still depends on the evolution of the virus, and people’s reactions to it, but for now the lights are turning back on for the global economy.
What are your expectations for corporate earnings growth? (Answer from Myles Zyblock)
July kicks off the period when companies will begin to report their second quarter earnings and provide any guidance that they might have about their outlook for the future. It is probably going to be a very weak quarter, with U.S. earnings down by close to 40% and global earnings off by more than 25%. These results will mark the weakest reporting period since the depths of the last financial crisis in 2008.
Then, based on the current trajectory of economic activity, we are likely to see the downward pressure on corporate earnings begin to moderate. This is not to say that earnings will boom, but the year-over-year growth rates should start to look somewhat better in Q3 and Q4. For 2020, however, EPS is likely to be 15-20% lower than what was recorded in 2019.
How supportive do you expect policymakers to remain? (Answer from Myles Zyblock)
Policy makers are doing their utmost to mitigate the negative economic effects from the global health crisis. Central banks have used a combination of aggressive interest rate reductions and liquidity injections to help stimulate activity and keep financial markets functioning as normally as possible. Fiscal policy makers have been reducing taxes, offering loan guarantees, and providing counter-cyclical income support to bridge the economic gap. These policy efforts, amounting to about $24.5 trillion dollars or 28% of global GDP, are unprecedented in their size and scope.
Yet, despite this year’s gargantuan efforts there seems to be no end to the policy intervention in sight. In recent weeks, at least seven emerging market central banks lowered their interest rates. The Canadian government extended its emergency response benefit (CERB) program for two more months. The Bank of England upsized its quantitative easing campaign by £100 billion. And, the Federal Reserve increased the menu of options for its corporate bond purchase facility from ETFs to include individual issuers that met the criteria for purchase.
Meanwhile, the Trump administration is said to be weighing a $1 trillion infrastructure program to help the beleaguered economy. China’s central bank has pledged faster credit growth. The U.K. has introduced a value-added tax cut. The International Monetary Fund (IMF) has built a $107 billion war chest to provide a potential safety net for struggling Latin American economies.
Global policy makers either do not see the recovery that is starting to take hold or have very little confidence in the strength of the recovery as it begins. Hence, they continue to pump the system full of stimulus.
Will the U.S. market outperformance vs. Canada continue? (Answer from Dan Bastastic)
- Given technology has been a major driver of the outperformance, do you expect the TSX will continue to underperform? Is it possible there will be a turnaround?
- U.S. is structurally advantaged vs. TSX
- Look at weights among sectors
- TSX is heavy energy, resource and financials
- Any of these have an issue and the market as a whole struggles
- Look at weights among sectors
- Does not mean you can blindly buy the U.S. market
- Rather it is prudent to be selective in your sectors for both the TSX and U.S.
- This year alone:
- Growth up over 11% and value down ~18%
- Science related stocks up 19% and financials down 19%
- In June the NASDAQ returned ~8% while the equal weighted S&P (normalizing for MEGA Tech stocks) is down ~11%
- For the TSX to recover we need to get through the virus and pandemic, have interest rates trend up, along with the US$ trending down
- If/when this occurs we will see emerging markets will start to do much better
- We link the TSX in with emerging Markets as it is the safest EM play globally
- The TSX gives you the greatest upside with a lot less downside
- We expect the TSX to at least match the performance of the S&P when we see value come back and interest rates/inflation stabilize or increase
We are living in a world of Helicopter Money. Do you have any concerns about the inevitable inflation to pay for it? Also how does that effect the long-term GDP as it seems a lot of people are saving here rather than spending? (Answer from David Fingold, Portfolio Manager, Dynamic Funds)
- First part of the question asks about inflation & second says there is going to be deflation
- Nobody is going to pay for this debt, countries never repay their debt
- They grow their GDP which reduces debt-to-GDP ratio over time or they just default
- Countries that can print own currency have never defaulted
- U.S. will not default, they’ve never repaid their debt, never unwound Quantitative Easing (QE), did QE from 1940-1952 and just let the bonds mature.
- No one has ever unwound the central bank balance sheet as you do not need to, the bonds just mature.
- Can’t be any inflation as the velocity of money has gone to nearly zero
- If Fed proceeds with yield curve control which is quite possible in the next few meetings, that will lower velocity of money even more
- Inflation is an impossibility
- Bigger risk is deflation which is driven by several things
- There’s a lot of worthless stuff out there, there’s no equity in shopping malls, office building, airlines, hotels
- Don’t own any of these assets, as an active manager, don’t care for these asset classes
- Don’t own any banks, so the fund is not exposed to mortgage or lease defaults
Does the U.S. election impact your investment decisions? (Answers from David Fingold and Dan Bastastic)
Fingold: The short answer to the question is no. We do not think anyone should be making investment decisions based upon elections. In the best-case scenario if the prediction you made for the election was correct, there is an interim election two years from then, and another Presidential election two years after that. It would be impossible to hold securities for the long-term if you have to take a view on politics, so we don’t do that. If we make an investment in a company, it needs to be a company that can do well regardless of who is in power. Our advice for investors who are trying to figure out who is going to win the election is don’t worry about that – just invest in good businesses.
- One thing we know is it does not matter who holds the President’s seat if the executive branch and Congress are split
- Markets and economy are not negatively impacted if you have a President who is Democrat or Republican and the Senate/Congress are opposite
- Those are generally most market friendly types of market in the U.S.
- If you asked us three months ago if a Biden victory would be a risk to the markets, the answer would be no
- That has now changed
- If Democrats take Presidency, Congress and Senate you have to start discounting the tax increases, removal of regulation cuts implemented by current administration
- These have been a huge factor in market returns and job creation over the past 4 yr
- You need to start to accept that this may change
- It would be prudent to be defensive heading into the fall if:
- You think the markets are very overvalued
- We get a Democratic sweep in the fall
- The narrative of the final months of the election cycle has been that taxes and regulations are going up
What is your currency outlook? (Answer from Myles Zyblock)
The U.S. dollar has been softening in value since late-March. On a trade-weighted basis, it has lost about 5.5% of its value relative to the currencies of its main trading partners since March 23. It is probably no coincidence that the U.S. dollar peaked at the same time that global equity and credit markets bottomed. The dollar is considered a relatively safe-haven currency and when the desire for safety starts to wane, so too does the demand for US dollars.
The Canadian dollar is among the set of currency beneficiaries of global risk-on flows. It is considered a more cyclical currency and has therefore benefitted from improving global economic activity. More directly, the Loonie has also found support from a higher oil price and the expected improvement in the country’s terms of trade.
The Canadian dollar has strengthened by close to 7% since late March. More upside seems likely. While the pandemic has hit the country hard, the damage has been less severe than that experienced by many other countries. Fiscal and monetary support should therefore help lift Canada out of its recession relatively quickly. Meanwhile, further gains in commodity prices and a less skeptical investment mood could provide additional supports for the Canadian dollar.
How could the extreme concentration of some indices (ex: S&P 500 FAANGS) impact index returns? (Answer from Myles Zyblock)
Every so often, market capitalization weighted indexes find themselves in a situation where a relatively small number of constituents dominate the behavior of overall index performance. You don’t have to go too far back in time to remember when Nortel alone made up over a third of the S&P/TSX capitalization weighting.
Today, we find ourselves in a similar situation in some indexes, like the S&P 500, where the five largest companies now comprise about 20% of the index’s total market capitalization. Narrow breadth is always resolved in the same way. The relative outperformance of these market leaders eventually gives way to underperformance.
Timing the reconciliation is the hard part. In the U.S., there is plenty of precedent throughout the 1920s to the 1960s when weighting for the top 5 stocks hovered in the 25-30% range. Said differently, there is no iron law which says that the big cannot get even bigger.
How has market performance in 2020 differed from past years given that typically defensive sectors (e.g., real estate) have been underperforming? (Answer from Myles Zyblock)
Naïvely adopting a low beta, or defensive, investment stance is often not as reliable in the next down-cycle as it appeared to be in prior periods. What is defensive today might not be defensive tomorrow. Today’s low beta stock or industry can morph into tomorrow’s high beta investment. This is because industry fundamentals change over time and the reasons behind each recession, or market dislocation, are almost never the same.
In the 2000 bear market, for example, Technology was one of the hardest hit sectors. It was the subject of over-investment and extreme valuations. Today, this same sector benefits from rock-solid balance sheets, is not nearly as overvalued as it once was, and has caught the tailwinds of accelerated technology adoption.
Through today’s current health crisis, we are concerned about empty hotels, empty casinos, and empty retail stores. Real estate companies, many of which have highly leveraged balance sheets, are vulnerable to an extended period of high vacancy rates. So the last few years of apparent safety that these companies have offered seems to have disappeared through the pandemic.
The benefit of owning equities has been their long-term rewarding returns. But we must not forget that they are also a relatively risky asset class. Given that the future is highly uncertain, a well-diversified equity portfolio typically offers the most reliable defense.
The market is not the economy and the economy is not the market. Why is it important for investors to recognize that? (Answer from David Fingold)
I understand the confusion because I think that the media is often telling people that the stock market is an indication of the economy, yet the stock market does not look remotely like the economy. The stock market, for instance, has a significant exposure to technology and healthcare, and the economy is very different. The economy has broader exposures to industries that simply are not publicly traded businesses.
People get confused when they see the unemployment numbers rising and the market going up. What they miss is that the market is going up because of resilient, high quality, profitable global businesses that consumers and businesses need to work with and need to do business with.
The other thing that I think confuses people is that they want to look at the market as an absolute indicator of the state of the economy and I think that is wrong. The stock market does not know good or bad, it only knows better or worse. Things were getting worse in late-February and throughout the month of March, and things have been getting better since late-March. In fact, if you were to overlay jobless claims versus the stock market, you will see that as the number of people who are claiming unemployment has fallen, the stock market has moved up. Again, that confuses people because they see a growing number of people who are unemployed, but they do not understand that we actually see green shoots. We see something that is less bad when several hundred thousand people claim unemployment this week than claimed last week. If less people are making claims, we see that as better, but it is clearly not good; however, that doesn’t matter – the stock market only likes better.