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Investment Commentary - Q2 2020


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Equity Markets


Equity markets experienced a very sharp recovery from the March lows. Investors have been encouraged by the flattening COVID curve and business activity recovery rate, despite being far from normal yet. Perhaps a more significant reason behind the enthusiasm has been the magnitude of government support aimed at tempering the depth of the COVID-19 crisis and encouraging the following economic recovery. The Federal Reserve has given all the indications it can to investors that it intends on being very accommodative until a real recovery has taken place. Investors responded by treating the crisis as more of a temporary hit to corporate profits as opposed to the protracted recovery expected before. This resulted in very strong returns across all equity asset classes during the quarter. Equity indices are still down for the year but much of the damage has been recovered.

Canadian investors breathed a sigh of relief this quarter. In most major markets, investors bought into the improving COVID-19 picture and significant central banks support, pushing prices higher. The S&P/TSX Composite, which was up 17% for the period, was also helped by an improving energy environment where crude oil prices recovered from being negative to approximately $40 a barrel. Breadth appears wide with ten of eleven sectors offering positive returns. However, most of the benchmark return can be attributed to the Materials sector (+42%), on the back of precious metal companies, and the Technology sector (+68%) on the back of Shopify, which saw its valuation inflate higher and higher, becoming the largest company in Canada based on its market capitalization. Consumer Discretionary (+33%) was also strong while Communications (-1%) and Utilities (+4%) were the weaker performers. Clearly, market participants were in risk seeking mode.

In the US, confidence continued to grow through the second quarter as investors watched countries around the world enter the early phases of re- opening, with mixed success. This was further aided by some positive “early data” on a potential vaccine and a strong jobs report in the US, suggesting things might not be as bad as feared. The S&P 500, with its heavy exposure to the IT sector, led the way globally, ending the quarter up 20.5%. Given the risk on sentiment and the oil price recovery, the loonie regained some of its lost ground in Q1, resulting in a 15.3% quarterly return in Canadian dollars for the index. After a period of broad selling with little discrimination, investors started choosing winners and losers from the pandemic, creating much larger deviations in performance this quarter. The market viewed anything with exposure to ecommerce or the “Cloud” as outsized winners in the post-pandemic world. Consumer Discretionary (dominated by Amazon) and IT led the rally, up 33% and 31% respectively. The risk-on sentiment was clearly visible, with all defensive sectors, like Utilities (+3%), Cons. Staples (+8%) and Healthcare (+14%), lagging the Index.

While lagging its US counterpart, which can be partly attributed to its lower exposure to the IT sector, international equities still rebounded strongly, finishing the quarter up 9.9% in Canadian dollars. Just like what we witnessed in the US equity market, investors viewed anything with exposure to ecommerce as outsized winners in the post-pandemic world. The Materials and IT sectors led the rally, up ~19% and ~18% respectively, helped by the risk-on sentiment. The more defensive sectors were clearly out of favour as Consumer Staples (+5%) and Utilities (+8%) were some of the main laggards. Energy was the only sector with negative returns in the quarter, falling out of favour after Shell cut their dividend to protect their balance sheet as energy prices remained depressed.

After the first quarter, we stated that investors had become fearful of the prospects that the pandemic would damage economic growth and corporate earnings. Although we agreed, we felt that this significant global disruption would be one that we would recover from. That confidence came in part from the significant fiscal and monetary measures that were being adopted to support this recovery. At that moment, equity valuations had fallen sharply, giving us the opportunity to add to our positions as we felt we were being very well compensated for the risks relating to the economic recovery. Today, we feel that valuations are implying a fair amount of good news amid the pandemic fight that has proven to be difficult to predict. We now feel that equities offer a more balanced risk-reward proposition at current levels and have chosen to further emphasize the defensive companies within our portfolios.

Fixed Income Markets

The second quarter of 2020 has been all about the recovery from the virus pandemic as many countries began re-opening their economies. The overall experience and containment of the virus has varied dramatically, as the recent escalation in new cases in the US is in direct contrast with other countries, including Canada, where cases have remained relatively low into the re-opening phase. This has created significant uncertainty around the economic outlook and hope for a “V” shaped recovery. The majority of economic data has improved steadily since the depths of March, with housing and employment leading the way, although unemployment remains elevated with a rate of 12.3% in Canada compared to 11.1% in the US. In Canada economic output reported in April showed an annualized decline of 18% over the level in February illustrating the magnitude of the impact this shut down has had on economic activity. In 2020, forecasted domestic GDP growth is expected to decline by 6.8% while the US economy is forecasted to decline by 5.5%.

Corporate and Provincial bonds performed well throughout the quarter as risk assets and the reach for yield produced strong demand. The speed of policy accommodation remains robust with support focused on market liquidity, including liquidity for risk assets. The potential for further policy support measures including yield curve control, forward guidance and added fiscal stimulus continues to be a focus for the market over the near term. As a result, interest rates are expected to remain low for an extended period as the path toward recovery is expected to be slow with a high degree of uncertainty. Most recently, added fiscal support in Canada was maintained despite the sizeable decline in government revenues. The supportive spending program is expected to produce a 2020/21 deficit of $343 billion, representing 15% of GDP, a rate not experienced since the late 1960’s.

During the quarter, the Bank of Canada maintained the overnight lending rate of 0.25% while the US Federal Reserve also held their policy rate at 0-0.25%. In Canada, the market is pricing in a 0.25% policy rate well into 2023 as core inflation remains subdued at 1.4% and the ground to recover on the economic growth front remains significant. During the quarter, yields declined across the curve and the curve flattened due to the decline in thirty-year yields. The decline in yields was driven by the Bank of Canada’s government buyback and quantitative easing activity as well as fundamental concerns relating to the speed of a recovery and escalating US virus cases. Over the period, two-year Canada bond yields declined 13 basis points to 0.28% while five-year yields dropped 22 basis points to 0.36%. Ten-year Canada yields declined 17 basis points to 0.53% while thirty-year bonds fell 31 basis points to 0.99%.

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