Markets rallied in April following the through reached on March 23rd. Once again, the S&P 500 led the way with a return of 12.8% (US$) for the month. This brought the year to date return to -9.3% for the US market, the less bad performing index among its peers. In Canada, the S&P/TSX increased by 10.8% ($C) in April while emerging markets (MSCI EM, US$) and international equities (MSCI EAFE, US$) rebounded by 9.2% and 6.5%, respectively.
For bonds, the Canadian Universe increased by 3.8% and the investment grade corporate bonds index returned 4.8% in April. Performance was supported by falling rates as the 10-year rate dropped by 0.15% and tightening corporate spreads. Nonetheless, Canadian investment grade corporate spreads stood at 1.94% at April’s end, almost double what they were prior to the crisis.
The US market performance was highly influenced by a group 5 leading companies, namely Microsoft, Apple, Amazon, Facebook and Alphabet (Google). This group now represents over 20% of the overall capitalization of the S&P 500 and their year-to-date performances as of April goes from 23.7% for Amazon to -1.5% for Facebook. Although some among this group trade at elevated valuations on a historical basis, these companies have so far been perceived as a relative safe haven by investors due to the service they offer, a generally strong balance sheet or a dominant position in their respective industries. This group has been leading the US market prior to the current crisis. However, the current situation accentuates their impact and lays bare the divergence in performance observed between the US market and the rest of the world as well as between Value and Growth style investing.
For the Canadian market, the material sector led the rebound in April (+33%) as gold-related stocks increased by 41.8% during the month. However, information technology is the best-performing sector in 2020 in Canada (+29.3% in April, +24.5% YTD). The sector is dominated by one company, Shopify, who briefly became the largest capitalization in front of RBC early in May. As of April, Spotify had returned +71% in 2020 and, thus, the company has a notable impact on this year's S&P/TSX performance of -12.36%. Excluding Shopify from the index would reduce its performance by 2.15% to -14.51%. Speculative activity does seem elevated on Shopify as it is trading at a price to sale ratio above 45. As a comparison, Microsoft trades at around 10 times revenue, a level considered relatively elevated.
This relatively impressive and quick bounce back for markets comes at the same time as some of the worst economic data ever seen for most of the population in western countries. Impacts of the different containment measures and the resulting sudden stop of economic activity are first visible through employment statistics. In April, 3 million jobs were lost in Canada (20M in the USA) which propelled the unemployment rate from 4% to 14% (4% to 15% in the USA). Markets are currently pricing in a recovery in the second half of 2020. Anticipation from Goldman Sachs illustrates fairly well the current consensus. The American investment bank forecast a sharp slow down in Q2 followed by a modestly high rebound in activity in Q3 and Q4 before a normalization in 2021. On the employment front, they anticipate a 9% unemployment rate in the US at year end. Basically, it assumes that all stimulative fiscal and monetary policies put in place will successfully support the economy and the laid-off employees over the next couple of months. This vision, albeit being the one we would wish for, seems too optimistic given all the virus related uncertainties still ahead. We believe that markets will remain fairly nervous with regards to how the situation evolves.
Before beginning this market review, we hope that you and your relatives are safe and healthy during this troubled period.
In March, markets fully and quickly integrated the negative potential economic impact of Covid-19 containment measures. Ironically, the longest US bull market in the history ended with the quickest fall in a bear market recorded as it took only 16 days from the end of February until mid-March to record a -20% drop. The swift fall lasted until March 23rd, when markets rebounded. As an example, the main US index (S&P 500) showed a return of -24.1% (US$) for the month on the 23rd before reversing and ending March with a loss of -12.3%. At the end of the 1st quarter, the cumulative loss for the S&P 500 stood at -19.6%. The uptrend observed in the second half of March continued in early April. However, we remain cautious with regards to this reversal which implies an expectation of a quick economic rebound (V shape recovery). It does seem premature as the epicentre of the crisis has moved to the US.
Most indices followed a trajectory similar to the S&P 500 in March. In Canada, the S&P/TSX registered a drop of -17.4% for the month whether the MSCI EAFE (US$, international equities) and MSCI EM (US$, Emerging markets) experienced losses of -13.3% and -15.8%, respectively. The US currency gained +5.6% vs the Canadian dollar (+9.2% in Q1) which helped Canadian investors. As for bonds, the Canadian universe returned a loss of -2% for the month while Canadian corporate bonds showed a loss of -5.4% over the same period.
To counter the sudden stop of most economic activities, governments and central banks from developed countries quickly announced multiple fiscal and monetary initiatives. Such measures whether aiming at supporting salaries of workers or loans and guarantees provided to companies although necessary will not be able to fully compensate the shock suffered by most countries. The economic toll is becoming visible with a sharp increase in layoffs and the corresponding surge in unemployment benefits. Without surprise, most economists expect a drastic reduction in GDP during the second quarter. UBS economists expect a reduction in GDP in the order of 2% to 3% for each month of reduced activity. In addition, Capital Economics forecast that governmental debt will likely increase by 10% to 15% as a result of all fiscal measures announced. However, these are minor considerations with regards to the current situation. The extent and pace of the recovery will ultimately depend on containment measures being progressively lifted. Certain countries where the outbreak seems to be under control such as China, Austria and the Netherlands have started to do so. How things evolve there will inform us on what could be our next steps.
As for central banks, particularly the Fed, tools used during the last financial crisis were deployed in a hurry along with multiple rate cuts. These tools obviously look to help restart the economy, but central banks were forced into actions in order to maintain liquidity in financial markets. This sudden need of liquidity was caused by an increasing demand for US dollars and US government federal bonds combined with massive sales of corporate bonds exchange traded funds (ETFs). Massive flows out of these ETFs caused an historic divergence between their value and the underlying indices they follow.
The recovery and re-opening of the economy will likely be gradual as the outbreak is brought under control and our comprehension of the virus mechanisms improves. We all see the news where we witness human ingenuity being put to work to fight this invisible enemy. All medical professionals are doing tremendous work to fight the initial outbreak. A longer term strategy is however starting to emerge. First, large scale serologic tests will be conducted, notably in Germany, to understand the extent of the virus propagation. Results are to be expected in the next few weeks and will likely help authorities improve containment measures. To help patients presenting acute symptoms, clinical trials on various antiviral medications are underway and should yield results in the next few months. Finally, various vaccine candidates are in development, but will likely only be available at some point in 2021.
The coronavirus monopolized the financial markets attention throughout the last stretch of February, as well as the month of March thus far.
Prior to that, the equity markets had started February strongly. Relatively optimistic regarding the containment of the virus, the Dow Jones, the S&P500 and the Nasdaq had recovered all losses from the prior month and had reached new highs on February 6. Encouraged by the Bank of China’s rapid intervention to offset the fallout of the virus on its economy (they lowered interest rates), the strong employment statistics in the United States (225,000 new hires) and the encouraging earnings results from American companies (for the last quarter of 2019), this positive market momentum continued strongly until February 19. At that point, the S&P 500 was up 5.0% for the month.
However, the virus spreading outside China, particularly in Italy, as well as the loss of lives linked to the disease in Japan, South Korea and Iran, fuelled concerns about the risks and consequences of the epidemic becoming a pandemic. Also, the possible impact of containment measures on affected and unaffected economies quickly increased the likelihood of a global recession. Consequently, panic invaded the markets and the VIX fear index ended the month at a very high level of 40.1, up 113% from the end of January. Since its peak on February 19, the S&P 500 had lost 12.8% over the last seven trading sessions in February to end the month down 8.4%. Energy demand weakened significantly and shrank oil prices by 13.2% (-26.7% for the year). As interest rates fell slightly throughout the curve, the Canadian bond universe returned +0.7% for the month, clearly insufficient to offset losses brought by equities.
While writing this monthly review of February, equity markets continue their painful decline in March. The bull market, started on March 9, 2009, finally ended 11 years + 2 days later March 11, 2020 (loss greater than 20% from peak). Russia and Saudi Arabia’s price war on oil sank even further the value of the commodity, fueling panic in the markets and forcing a trading halt on Monday morning, March 9. Below $40 a barrel, many producers could quickly find themselves in financial difficulty (such as the American shale gas producers). Moreover, President Trump’s surprise announcement (Thursday, March 12) to ban Europeans from entering the United States caused several exchanges to experience their worst daily losses since the crash of 1987, but only to see them bounce back just as spectacularly the next day.
Escalating government measures undertaken to weaken the pandemic make it hazardous to predict the impact of this tragedy on the world economy. According to a Bloomberg report published at the beginning of last week, the probability of a global recession in context of a well contained scenario was above 50%. Prior to the virus’ outbreak, the global economy was on an upward trend forecasted to grow by 3.3% in 2020. It was revised to 2.6% in context of regional epidemic containment better than what was witnessed in China, Italy and South Korea. In the event of a global pandemic with major epidemics in all the major economies, growth was revised to 0% for 2020. Based on the events of the past week, in our opinion, the probability of a decrease (growth below zero) is very high.
The nature of the crisis (a very dangerous virus) as well as the speed and amplitude of the market downturn (-30% in 3 weeks), remind us that such market movements cannot be predicted. It is just as impossible to predict when and how fast the recovery will follow, but it could be just as dramatic.
Likewise, we do not know when the scientific community will have the upper hand on this virus, but we are confident that they will succeed. For the intrepid investor there are opportunities in the market, we must resist the urge to sell.
Encouraged by the signing of the Phase 1-trade agreement between the United States and China, the stock markets began the year strongly, despite the escalating geopolitical tensions between Iran and the United States. Also, early financial results of US companies for the fourth quarter of the year, as well as the December employment numbers published in January satisfied investors and contributed to the rise of US stock indices to new records.
However, the January 19th announcement of the first case of coronavirus in the US (Washington state) dampened the stock market momentum. The spread of coronavirus outside of China and its risk of slowing down the global economy raised the fear index (VIX) by +37%. The impact of this virus on Chinese and global economic activities is unknown but will certainly be greater than in 2003 when SARS disrupted markets. The Chinese economy now represents 15.8% of the world economy compared to 4.2% at the time.
Several companies operating in China were quickly affected by this virus, including iPhone producer Foxconn who produces the majority of all Apple’s phones in the city of Zhengzhou. In its city factory, where it employs at times nearly 200,000 people in the assembly of the popular phone, Foxconn had to stop all its operations. Starbucks is another example, it generates 10% of its total sales in China and had to close half of its 4,100 locations in the country. These two companies lost 9.9% and 9.5% respectively during the last trading sessions in January.
The Chinese equity index MSCI China lost 4.8%, while the MSCI ACWI, the global index of developed and emerging markets, lost 1.1%. Recall that these indices had produced in January 2019 performances of 11.1% and 7.9% respectively. In the currency market, as the loonie lost 1.8% against the US dollar and 0.5% against the euro, foreign currency investments returned a foreign exchange gain for a Canadian investor.
As commodities are vulnerable to disruptions on China’s economic growth, oil (-15.6%), natural gas (-15.9%) and copper (-10.0%) suffered in particular. The January stock market performance was challenging for managers who advocate value-style management and hold cyclical securities related to commodity prices. As a result, the value index underperformed the growth index by 4.5% during the month. However, portfolio managers surveyed believe that the spread of this virus appears to be contained and although this virus has an effect on the short-term, it will not affect long-term outcomes and may create purchasing opportunities.
All in all, the uncertainty caused by this virus has raised the level of stock market risk and favoured bonds. Interest rates declined sharply throughout the Canadian interest rate curve pushing the Canadian bond index return to +2.9% for the month. As of January 31st, the 10-year Canadian government bond yielded a +1.29% return (down -0.43% from last month) compared to a 2-year bond that yielded a +1.44% return.
In December, global markets closed a very good year in 2019 on another good month. The flagship US market index, the S&P 500, posted a +0.7% ($CAN) performance in December to end the year up +25.2% ($CAN). S&P/TSX’s performance in the Canadian market was more modest at +0.5%, but the Canadian index still finishes 2019 up 22%.9%. For their part, international equities and emerging market equities ended 2019 with December returns of +0.9% (MSCI EAFE, $CAN) and +5.1% (MSCI EM, $CAN) and annual returns of +16.8% ($CA) and +13.2% ($CAN), respectively. In terms of the Canadian bond universe, although the return for the year was more than respectable at 6.9%, the month of December was more difficult with a negative performance of -1.2% after the interest rate turnaround, notably the 5-year rate which increased by +0.2% during the month.
2019 was a year in which market performance contrasted sharply with the climate of geopolitical uncertainty. Nevertheless, 2019 is a good example of the anticipation that financial markets can exhibit. Indeed, the expansion of the price/earnings multiple explains almost all of the performance for various regional indices, as per an analysis by the US bank JP Morgan. In some regions, particularly Japan and emerging markets, there has even been a decline in earnings. An upward movement in multiples indicates that investors anticipate an improvement in future conditions and vice versa for a contraction. In 2019, the support of the central banks to counter the manufacturing slowdown coupled with signs of a detente in trade-related tensions with a partial agreement between China and the United States are two factors that contributed to the moderate upturn in optimism occurring this fall.
Where does that leave us for 2020? The various markets, including the US market, are again at historically high levels of valuation, similar to those reached at the end of 2017. It is therefore important that actual results eventually reflect the positive expectations that pushed the markets up at the end of 2019, otherwise multiples could contract. On the Central Bank's side, the Fed has announced that for the moment, the three rate cuts of 2019 should suffice and that it is observing how things develop. On the trade front, under normal circumstances, you could expect that things would dial down a bit during an election year in the US, but the current American administration has accustomed us to unexpected behaviors. On the economic front, the service sector continues to support growth in the major developed countries for the moment and some figures from Asia, including Korean exports, seem to indicate some stabilization. We therefore continue to advocate a disciplined and prudent approach.
With the decade just ending, a look back to what has happened is in order. For financial markets, the strong performance of the US market was impressive with an annualized performance of 13.6% (S&P 500, US$) well above other regions. In comparison, the Canadian TSX posted an annualized return of 6.9% (CA$) over the decade, just ahead of international equities (+6.0%, US$) and emerging markets (+4.0%, US$). Will the next decade be similar? They rarely are, and we can be sure that a few surprises are waiting for us. With that, we wish you all a prosperous and healthy 2020.
In November, developed countries’ equity markets responded favourably to the US-China trade negotiations. The US and Canadian markets dominated with returns of +3.6% each in their respective currencies. The VIX fear index quietly declined to its lowest closing level in 15 months (November 26). In 20 trading sessions in the US (21 in Canada), the S&P 500 Index closed 14 times at a higher level than its previous day’s close (the S&PTSX 15 times). In doing so, the American index broke its record 11 times and the Canadian index did the same 8 times. International equities also performed well (+1.1% for the MSCI EAFE $ US), however, they are 21% below their pre-financial crisis record of October 31st, 2007 (in $ US). To illustrate the impressive return gap between markets, US equities surpassed their pre-crisis peak by 101% (13% for Canadian equities).
Recent employment statistics in the US contributed as well to market performances. Despite the strike at General Motors (more than 40,000 strikers), 156,000 new jobs were created in October and 266,000 in November (return of strikers). In addition, this statistic for the month of September was revised upward by 44,000 to reach 180,000 new jobs. The unemployment rate has fallen again to 3.5% and according to Bloomberg this statistic will reach 3.3% by 2020. If this is the case, it will be the lowest unemployment rate in an election year since Republican Dwight Eisenhower’s victory in 1952.
Jerome Powel, Chairman of the FED, announced that he saw no imminent risk to the US economy which is now in its 11th year of expansion and its Q3 growth has been revised upward (2.1% versus 1.9%). However, he would like to see the US Congress improve the budget deficit in order to replenish the toolbox for the next recession. In the eurozone, economic growth in Q3 remained unchanged at +0.2%. A heavyweight of the eurozone, Germany, narrowly avoided the technical recession in the last quarter (+0.1% in Q3 and -0.2% in Q2). The pressure on German policy makers is increasing to break the “black zero” policy during this difficult period for manufacturing production.
To recap on the trade negotiations, markets were anticipating a partial agreement by the end of the month. Negotiators from both nations indicated that the lifting of certain tariffs would follow a partial agreement, of which China is in need for, as its exports to the US market are at their lowest level of the past three years. The latter has withdrawn the ban on imports of American poultry. However, it is expected that the Trump administration will impose new tariffs of 15% on $160 billion of new Chinese goods on December 15 if no agreement is reached. The market is anticipating a last-minute agreement or the extension of the deadline, of which we’ll know the developments very soon.
Equity markets carried over their positive performance from September in October, with the exception of the Canadian S&P/TSX which returned -0.86% ($C) during the month. Emerging markets, international equities and US equities all reported strong numbers with performances of 4.23% ($US), 3.6% ($US) and 2.17% (US) respectively. On the Canadian fixed income side, the overall bond universe performance was slightly negative at -0.17% whether the shorter-term universe returned a positive 0.22% for the month. This divergence can be explained by a slight steepening of the yield curve where maturities of 5 years and beyond saw rates increased slightly whether rates on maturities below 5 years stayed flat or decreased slightly. This trend of increasing rates for longer-term maturities is still ongoing in November in most developed markets (Canada, the US, Germany).
A change in narrative occurred in the market toward the end of August. This narrative is fuelled by a few themes feeding off each other. Firstly, renewed and ongoing trade optimism in the US-China trade front with the so-called phase 1 agreement hints at a potentially improving situation in the future. Secondly, we have global central banks entering into support mode to help a slowing industrial sector by easing monetary conditions, just as they did over the last 10 years for the overall economy. On this front the Bank of Canada is the exception by staying put. Finally, there are signs that some economies are stabilizing coupled with talks of fiscal support from governments, notably in Europe. Add all of this together and you get a lower US currency which tends to help emerging economies as well as improving growth prospects which in turn supports cyclical sectors where valuations were depressed, hence the better recent performance from Value equity managers versus their Growth counterparts.
With all of the above, we believe it is better to remain prudent. We keep questioning ourselves on the marginal impact that monetary policy can have after 10 years of extensive use. However, in the end what still matters for markets is how well or poorly companies are doing. On that front, with almost all numbers for the third quarter published in the US, Canada and Europe, we can gauge the situation. Overall, reported sales and profits were generally in-line with expectations, but quarter on quarter growth was weak, flat to slightly negative depending on the region. Thus, results aren’t stellar, but aren’t indicating the sharp slowdown feared in the summer. Consequently, it is reasonable to expect the global economic situation to stabilise going forward and have a moderate rebound over the next few quarters.
Led by international equities, major stock market indices rebounded in September. Canadian equities reached a historic record close of 16.899 points on the 20th and returned +1.7% (in $C) for the month. Canadian bank securities benefited from a steepening of the yield curve and returned +7.3% (as they borrow in the short term and lend in the long-term market). Energy stocks performed very well, especially the Canadian oil and gas exploration and production subsector that returned +11.6%. That said, portfolio managers with a “value” management style performed particularly well. Global value equities outperformed growth equities by +3.5%. The important gap in valuations between these two styles has become difficult for bargain hunters and strategists to ignore and a moderate price correction occurred during the month.
The equity market responded favourably to the announcement that the US and China would meet in Washington on October 10th for a 13th round of negotiations. In acts of goodwill, both nations have been mitigating their tariff interventions. The United States delayed a tariff increase originally scheduled for October 1st until October 15th, and China gave the green light to its companies to acquire American agricultural goods, notably pork and soybeans. According to Bloomberg Economics, the impact of not reaching an agreement by 2021 is estimated at -0.6% on US economic growth, -1% on China’s growth and -0.6% on the world economy’s growth. If an escalation of this trade war involving tariffs of 30% on all exchanges were to arise, the impact on growth would be -1.4% in the United States, -2.1% in China and -1.3% for the world.
Aware of the consequences of this trade war, the FED and the European Central Bank (ECB) intervened again. It was a divided FED committee that reduced its target rate range to 1.75-2% (down 25 bps). Citing the strong labour market as well as the resilience of consumer spending, the FED still sees a favourable economic outlook for its economy which grew by 2% in the 2nd quarter. This second and possibly final rate decrease for the year is considered an additional insurance policy. In the eurozone, economic growth is barely observable: 0.2% in the 2nd quarter and 0.1% of expected growth for the quarter just ended. As mentioned in our August market review, Germany is suffering from the weakness of the manufacturing sector and the ECB intervened in September by lowering its policy rate to -0.5% (10 bps decrease). It has also restarted the quantitative easing program as it will start buying back 20 billion euros worth of government bonds each month.
These events improved the slope of the interest rate curve, increased rates and the Canadian Bonds Universe lost -0.8%. All in all, although the stock markets took advantage of easing trade tensions and appreciated the measures central banks are taking, they remain very sensitive to the developments of the trade war.