Markets continued to advance for a third consecutive month in April. Topping the list, the S&P 500 finished up 5.34% (in US $), followed by international equities with a gain of 3.09% (MSCI EAFE, in US $) for the month. The MSCI Emerging Markets (US $) and the Canadian S&P/TSX indices also had a strong monthly performance, appreciating by 2.50% and 2.39%, respectively. After 2 months of favoring value stocks, April saw growth stocks regaining investors’ preference with gains of 6.33% (MSCI World Growth, US $) compare to 3.21% for the value index (MSCI World Value) . Finally, the appreciation of the Canadian dollar against the US currency subtracted -2.31% from US denominated returns.
Minister Freeland presented her first official budget in April. According to an analysis by Bloomberg economists, about a third of the additional spending of 101 billion over the next 3 years is an extension of the Covid related measures already in place. Otherwise, the largest share will go to a new Canadian child care program based on the model we have in Quebec. Some may decry or minimize the scope of this program, but studies by Professor Luc Godbout of the Université de Sherbrooke have found that the Quebec system helped increased the participation rate of women in the labour force which had a measurable and lasting positive impact on the province GDP. Consequently, this social program, if properly implemented, could have a significant and lasting impact on the Canadian economy. South of the border, the Biden administration has started leaking information about what infrastructure plan it wants to put in place. This plan is valued at 2.25 trillion US $ (!!!) or 280 billion per year over 8 years and promises to be difficult to negotiate with Congress since it involves tax increases, both corporate and personal. The first estimates by Bloomberg economists predict an impact on annual GDP of 0.1%/year and 2.2 million jobs created with the majority of the program in physical infrastructure and the balance invested in research & development, education and health. It appears to be a lot of money for little real impact.
After a few difficult months, bond markets posted a slight positive performance of 0.06% for the Canadian universe and 0.01% for the corporate segment in April. This performance contrasts with the spectacular rebound in certain commodities over the past year. Notably, lumber whose one-month forward contracts were up 48.7% in April and nearly 369.3% year-on-year. Other commodities playing an important role in transport and industrial value chain, oil and copper, have seen significant gains during the last 12 months, at + 237.5% and + 90.3%, respectively.
Some observers point to these increases as proof that the return of inflation is only a matter of time. While this is possible, it is worth remembering that the supply of a raw material that grows or needs to be extracted, in other words the total quantity available at any given time, is relatively fixed over the medium term. Prices are therefore the first conduit through which a demand shock manifests itself before output adjusts. We suffered a major demand shock during the spring of 2020 followed by a strong rebound in some sectors, which partly explains supply disruptions and adjustments. To have a lasting inflationary impact, these imbalances would have to become nearly permanent. It is too early to say, but it is true that residential renovation projects will cost more in the coming months.
Exceptionally, only available in French this month
In January, large market capitalization indices for developed countries fell slightly (-1.0% for the MSCI World in US $), while those of emerging countries as well as those of small-cap stocks appreciated nicely (3.1 % in US $ for MSCI Emerging Markets & 2.4% for MSCI World small caps). This phenomenon contrasts what has taken place in recent years, when just about only US large caps concentrated in FAANG stocks were popular amongst investors.
After a good start to the month driven by the global rollout of vaccinations, the promise of new fiscal stimulus and following surprising Democratic victories in Georgia for two Senate seats, the MSCI World was up 3.0 % (in US $) as of January 20th. However, concerns over vaccine supply delays dampen the excitement towards the end of the month.
An unusual event took financial news by storm in January, a war between day traders coming together with the help of trading apps such as Robinhood against Wall Street hedge funds and their short positions. This war highlighted the rise of online investor forums forging battalions to manipulate stock prices of specific companies regardless of their financial fundamentals. Struggling companies like Gamestop and AMC had become preys to hedge funds who borrowed these stocks and sold them short, hoping to buy them back for less and reimburse their borrowing down the road. However, the battalions were able to push prices very high, Gamestop hit a 1700% rise at some point in January, causing heavy losses for hedge funds. To answer margin calls, hedge funds had to buy back these companies, pushing prices even higher! Melvin Capital, a hedge fund that bet against GameStop, lost 53% of its value in January. They had to be rescued by Citadel and Point72, two other hedge funds, that provided a $ 2.75 billion dollar lifeline. Although this war involved only a few stocks, the market ended the month wobbling and stunned by what had happened.
In the foreign exchange market, the Canadian dollar lost -0.4% against the US dollar but gained 0.6% against the euro. The VIX markets "fear" index climbed to a level slightly above 33, up 45% from its close on December 31st. As for the bond market, interest rates rose considerably on the long-end portion of the Canadian curve with an increase of +0.18% for the 10-year and + 0.25% for the 30-year (+ 0.18% for the 10-year and + 0.22% for the 30-year in the US). The 30-year Federal Bond now offers a yield of 1.48% in Canada (1.87% in the US). Consequently, the Canadian bond index produced a negative return of -1.1% and the corporate bond index produced a negative return of -0.5%.
Let's not forget about the tragic assault on Capitol Hill in Washington on January 6th, but the stock market didn't give much importance to it ...
We would first like to start by whishing all our clients and partners a Happy New Year. Following a trying 2020, we hope that you and your loved ones will stay safe and healthy for the upcoming year.
Markets concluded 2020 with another positive month in December but were less exuberant than in November. Emerging markets equities (MSCI EM) increased by 7.4% in December (in USD) and finished the year as the leading region with an annual performance of 18.7%, slightly above the S&P 500 which returned 3.8% (in USD) in December to end 2020 up by 18.4%. As for other regions, International equities (MSCI EAFE, in USD) and Canadian equities (S&P/TSX) ended 2020 up by 8.3% and 5.6%, respectively. These respectable performance numbers hide all the commotion that occurred last year. It is good to recall that when markets bottomed on the 23rd of March, most were down by more than -30%. The following rebound was thus extremely fast. It took the S&P 500 only 148 days (August 18, 2020) to regain the lost ground on its way to finish the year strongly. As a comparison, it took nearly 4 years following the 2008 crisis for the S&P 500 to get back to its pre-crisis peak.
As is customary at the beginning of a new year, investment strategists took their crystal ball out and gave their forecasts, whatever they might be worth. As per the Bloomberg consensus, economic activity should rebound sharply in 2021, especially in the second half of the year once vaccine rollouts are well underway. Expected real GDP (excluding inflation) growth in 2021 is anticipated to increase by 4% in the US, 4.4% in Canada and 8.2% in China. This strong rebound is in large part the result of the unprecedented fiscal and monetary stimuli initiated around the world. Global aggregate monetary and fiscal support measures are estimated to be reaching to a staggering amount of USD 28 trillion as per KKR and Cornerstone Macro. For markets, most forecasts are moderately optimistic. As an example, the bottom-up (company by company) forecast compiled by Bloomberg anticipate that the S&P 500 will end 2021 at a level of around 4,000 vs 3,756 at the end of 2020. Adding up expected dividends of 1.61%, this would result in a return of 8.1% in 2021. As well, most strategists anticipate that the economic rebound will favor cyclical companies and small cap equities which have been more affected by the slowdown. This should help close part of the return gap between value and growth as well as favor international and emerging markets equities.
For yields and bond markets, the almost unanimous view is that short term rates will stay low for an extended period, in accordance with what central banks have advertised as their preferred course of action. Consequently, expected returns for bonds are fairly low considering that the Canada 5-year rate stood at 0.41% at the end of December. As well, investment grade credit spreads have tightened back to levels seen prior to the pandemic (1.18% in Canada at the end of December). Due to all the stimuli announced and the indebtedness level of governments, some are expecting a moderate level of inflation in the medium term. We will have to keep an eye on this…just like we have since 2008.
On the geopolitical front, like a lot of people, we hope to refer to Mr Trump as the President of the United States for one last time in this letter. Mr Biden should bring back a level of cohesiveness to the White House when he will be officially sworn in on the 20th of January. However, numerous challenges are awaiting him as sadly illustrated by recent events. As northern neighbors, we can only hope that things will calm down.
In November, all stock market indices produced exceptional results. Canadian stocks returned 10.6% (S&P/TSX in $C), US stocks 10.9% (S&P 500 in $US), international stocks 15.5% (MSCI International in $US) and emerging market equities 9.3% (MSCI EM in $US). Global value-style stocks (15.1% in $US) outperformed growth-style stocks (10.9% in $US). Canadian stocks in the energy sector rebounded 19.5% and financials 16.4%. In the foreign exchange market, the Canadian dollar gained 2.5% against the US dollar and 0.2% against the euro. In the bond market, credit spreads narrowed, and the corporate bond universe returned 1.7% while the entire universe returned 1.0%.
The victory of Democrat Joseph Robinette Biden Jr in the US presidential elections was the first of two major stock market surges during the month. Banking on decency, unity and national healing, this lawyer with a long political career won his bet and will become the 46th President of the United States. Although this long-awaited event occupied almost all the financial media attention during the month, successive announcements of three effective coronavirus vaccines propelled the second stock market surge.
The stocks most affected during the market debacle of February and March 2020, i.e. airlines, cruise lines, banks and other cyclical stocks exploded upon the announcement of Pfizer's vaccine results (the first to announce results). This rebound in “value style” securities was eagerly awaited, the return differential with "growth" style securities had reached an all-time high, higher than the gap seen during the tech bubble in the late 1990s. The future will tell if this divergence in returns between these styles is on its last breath.
However, early sings point towards the beginning of a new economic cycle. Notably, the weakening US dollar and the strong rebound of small-cap stocks. In 9 out of 10 post-war recessions in the United States, US small cap stocks outperformed large cap stocks during the recovery by an average margin of 11%. In addition, for global large cap stocks, cyclical sectors and the “value” style have outperformed during the recovery phases of the last two recessions (tech bubble and in 2008).
How can we talk about the month of October 2020 without mentioning the US elections? There was a time when monetary policy was the central point in dissecting market performance. Politics are now taking centre stage.
The increase in Covid-19 cases since the start of the school year and the Trump administration's nonchalance to control the increase has led to a second wave that exceeds the daily number of cases reached in the first wave. Since September and more so in October, financial markets fear the resurgence of lockdown measures and their well-known consequences on the economy. Towards the end of October, it became increasingly evident from this battled election, that no party (Republican or Democrat) was going to make concessions on the economic stimulus package to support workers affected by the recession. The markets gave their point of view and apart from the emerging markets, the developed large-cap markets ended down between 2.7 and 4.5% US$. Once again, the Canadian market is down this month by 3.1% for a year-to-date return of -6.1%. To say the least, oil prices down by 11% in October and 41% for the year, is not helping.
Despite two consecutive months of decline for the US equity market, it still cannot be concluded that this market is now reasonably priced. According to Ned Davis Research, the S&P 500 (US equities) trades at a multiple of 2.5x sales, which they believe would be a level not reached since 1955 and also the total capitalization of the S&P 500 reaches 1.78x the US GDP, its highest level since 1925. It would not be surprising if the American market becomes at some point the worst performing compared to other major markets on the planet. Will this time come when tech stocks (mostly concentrated in the US) get their excessive valuations corrected? To ask the question is to answer it.
Economically, US GDP still grew 33.1% on an annualized basis, which is the best quarter growth on record, but it followed a 32.9% decline in the previous quarter. Sometimes it is more representative to compare data from quarter to quarter than to compare numbers on an annual basis (which is usually the consensus to reflect changes in a country's GDP). If we compare from quarter to quarter, the American Q3 increased by 8.91% compared to Q2, while Q2 was down by 9.59% compared to Q1, and the Q1 was negative by 1.76%. That's a lot of data, we agree, but in 2020 the data is so extreme that it becomes more difficult to put it into perspective and sometimes we have to show the results from a different angle.
Jobs creation is another important factor from an economic point of view. In the US in October, 638,000 new jobs were created, lowering the unemployment rate to 6.9%. This represents a decrease of 1% compared to the previous month, which is a slower reduction in the unemployment rate than in the last few months. Let’s not forget that it hit a post-war record of 14.7% in April 2020.
We cannot ignore a dazzling start to November on the stock market in response to the conclusion of the American elections, but especially to the announcement of the arrival of a promising vaccine by Pfizer. However, we have enough experience to appreciate the stock market rise without getting carried away too quickly.
Back to school and a drop in temperature, sourced fears of a second wave of Covid-19 and a re-confinement. Adding to this the turmoil surrounding US upcoming elections, September was filled with uncertainty and brought down stock markets; -2.1% in Canada (S&P/TSX, $C), -3.8% for American large caps (S&P 500, $US). Internationally, the MSCI EAFE fell by -2.6% ($US), emerging markets did slightly better (-1.6%, MSCI EM, $US) than developed markets (-3.4%, MSCI World, $US). The US dollar, a safe haven in times of uncertainty, appreciated 2.3% against the Canadian dollar, improving returns for Canadian investors. As for fixed income, the Canadian bond universe rose by +0.32% following small rate compressions. The government bond universe (+0.43%) did slightly better compared to its corporate counterpart (+0.01%).
Atypically, the big “tech” companies were roughed up the most. In $US, Tesla -13.9%, Facebook -10.7%, Apple -10.3%, Alphabet [Google] -10.1%, Amazon -8.8%, Microsoft -6.7% and Netflix -5.6%, all major constituents of the NASDAQ 100 index, led that index down 5.7%. This ended an eleven-month streak of NASDAQ 100 outperforming the equally weighted MSCI World (-2.4% in September). Throughout this stretch, the “tech” index outperformed by more than 50%! Moreover, September was the first month this year where US value style indexes outperformed growth equivalents. Markets are closely monitoring the Covid-19 vaccine development, good news could trigger a market rotation towards sectors that have been pounded since the pandemic started.
Job creation in the US (661,000) arrived below expectations (859,000) and appeared to be running out of steam compared to the 1.4 million jobs gained back in August, additional stimulus seems warranted. Nonetheless, the unemployment rate dropped to 7.9%, perhaps an illusive level as many unemployed have stopped looking for work. In September, alone, 700,000 people gave up their search.
As we enter the final stages of the US presidential campaign, history tells us the incumbent president is rarely defeated in a re-election. However, various studies show that a deteriorating labour market in the 3 quarters prior to the election (currently the case) tends to favour the candidate out of office. Various national polls lean heavily towards this same conclusion. However, the result will be greatly influenced by the 40% of Americans who do not identify to a specific party. The turnout among these voters will determine the outcome in key states. It is noteworthy that most independent voters, around 60%, are dissatisfied with President Trump's handling of the pandemic. Yet, apart from the higher volatility generally seen in the markets before the elections, longer-term market impacts are difficult to assess. Historically, when a Democratic candidate defeats a Republican president, stock market performance during the election year is on average negative (-4.8%, MSCI World $US) but bounces back heavily (+28.6%, MSCI World $US) in the inauguration year, an observation, however, established on a small sample (5).
In August, markets were on the rise again as the year-to-date performance of global equities (MSCI World) returned to the positive side (+5.7% in US$) following a performance of +6.7% (in US$) during the month. The situation was equally positive in the United States (+ 7.2%, S&P 500 in US$) and internationally (MSCI EAFE in US$, +5.2%). The rise in the US market also represents the best performance recorded during a month of August in 30 years during a period which is normally quieter for markets. The returns of the MSCI Emerging Markets and the Canadian S&P/TSX were more modest, but still appreciable with +2.2% (in US$) and +2.3%, respectively. Due to the significant appreciation of the Canadian dollar, however, -2.7% should be deducted from the performance in US currency.
Once again, major tech stocks and the growth style led the charge with some exuberance. The perfect example is Tesla's performance over the month. After announcing a 5-for-1 stock split on August 11th, the stock increased by +71% through the month end. All kinds of reasons have been put forward to explain this move, but a stock split does not change the total value of a company. It simply divides it into a greater number of shares. You can admire Mr. Musk and think Tesla's cars are revolutionizing the industry, but we are still skeptical of what happened. Tesla also illustrates the risk posed by extreme movements that can suddenly tip over. In early September, the stock plunged by -33% in 5 days before pulling back.
As for the Canadian bond universe, it dropped by -1.1% while its corporate investment grade segment (BBB and +) did slightly better, but still fell by -0.5%. A rise in 10-year rates of + 0.18% contributed to this underperformance. With credit spreads being a measure of investors risk appetite, it is interesting to note how they have tightened since the peak in mid-March especially for the investment grade corporate bond segment. In both Canada and the United States, spreads on these bonds are now hovering around 1.3% after peaking in March at 2.7% and 3.8%, respectively. Note that movement in spreads on high yield bonds were much more pronounced over that same period. The return to spreads that are in line with long-term historical averages while we are still in a relatively uncertain environment for the foreseeable future demonstrates the persuasive force of central banks interventions.
The economic recovery continues with advanced purchasing indices being in expansion territory for all large economies (United States, Europe, China) and Canada. This is good news by itself, but it hides the extent of the catch-up left to be done. Although the unemployment rate has fallen to 10.2% and 8.4% in Canada and the United States, the number of jobs lost to be recovered remains high (1.1M in Canada and 11.9M in the US). The lasting impact of the current crisis lies in the proportion of those lost jobs that will end up being permanent and not temporary. This will in part dictate the strength of the recovery. A Washington Post article citing a Labor Department study forecasts that between 2.5 and 5 million of the jobs lost since the end of February will become permanent. For our neighbours south of the border, extending temporary relief measures could help counter this impact, but negotiations seem to be in a dead end with the start of a presidential election campaign that promises to be very acrimonious.
In July, markets continued their rally as the World Market Index rose by 4.8% for the month (-0.9% for the year in US $). However, this market rally is proving to be uneven as a minority of large-cap stocks, resistant to the pandemic economy, improve the results of global market indices. This, as the price of gold continues its upward trend supported, among other things, by its safe haven attribute, by the decrease in demand for the greenback and by anemic interest rates.
The undisputed leader this year, the Nasdaq 100 "technology" stock index returned +7.4% in July and +25.6% year to date (in US $). This index's six largest positions represent 49% of its weight, they are in order: Apple, Amazon, Microsoft, Facebook, Alphabet (Google) and Tesla. At the opposite end of the spectrum is the MSCI World "Value" subindex with the 6 largest positions being: Johnson & Johnson, Procter & Gamble, JP Morgan, Home Depot, Berkshire Hathaway, and Verizon. Its return was +2.6% in July and -15.3% since the start of the year (in US $). The return spread between these two groups of securities is remarkable, reaching over 40% since the start of the year. In comparison, the Nasdaq 100 trades at a price/earnings ratio of 35 (21 for the MSCI World Value), a Price to Book Value ratio of 7.8 (1.5 for the MSCI World Value) and produces a dividend yield of 0.8% against 3.5% for the MSCI World Value. Note that the Berkshire Hathaway conglomerate led by value-style investor Warren Buffet is down 13.6% since the start of the year compared to the +2.4% return for the S&P 500 index (in US $).
This year, it is considerably difficult to keep up with the indices or do better without owning the top five stocks listed above which make up nearly 22% of the total market cap of the S&P 500 (Tesla is not included in the index despite a market capitalization of 289 billion) or have an important weighting in the technology sector. Several major industries in the global economy are sharply lower since the start of the year including energy at -37.6%, commodity producers at -25.6%, financials at -20.9% , real estate at -11.4%, infrastructure at -10.6% and industrials at -10.1% (all in US $). Among the 11 economic sectors, four have positive returns in US $ this year: telecommunications +4.6% (dominated by Facebook, Alphabet and Netflix), healthcare + 6.0%, consumer discretionary +8.9% (dominated by Amazon, Home Depot and Tesla) and technology +20.8% (dominated by Apple and Microsoft).
Economic statistics for the second quarter are as expected very difficult. The American consumer reduced its spending by nearly 35% in the second quarter of the year causing a reduction in economic growth of almost 33% during the same period (annualized statistics). The price of gold, up 29% this year, is not insensitive to the difficulties faced by US authorities in containing the spread of the coronavirus in its economy. It is also not insensitive to government budget deficits and the very accommodating policies of various global central banks. Also, because interest rates are so low, the opportunity cost of holding gold (which does not pay interest) is no longer material. While waiting for the promised vaccine, demand for this commodity who’s worth often relies in the eye of the beholder, has reached an all-time high of $ 1.976 in late July.
The VIX "fear" market index fell 20% in July, but still stands at a relatively high level of 24.5 (average of 17 over the past 10 years). The Canadian bond universe produced a return of +1.3% for the month, while corporate bonds’ return was slightly higher at +1.9% as interest rates fell slightly throughout the curve. The 10-year Federal Bond now offers a feeble yield of +0.48% in Canada (+0.55% in the US).