COVID-19 has wreaked havoc on the world economy, which is set to contract the most since WWII this year as governments shut down large segments of their economies to slow the spread of the virus. There are some signs of recovery as the latest data from the CPB Netherlands Bureau for September showed that real world trade in goods was just 1.5% below its December 2019 level. Confidence in the timeliness and effectiveness of a Covid-19 vaccine has contributed to confidence that we can return to a kind of ‘New Normal’. The success of this will depend on finding an acceptable trade-off between public health, the economy, and personal freedom.

China was likely the only major economy to grow in 2020, as it had more time to recover from the coronavirus hit. Structural weaknesses in China’s economy (demographics, rising debt burdens, and diminishing returns on investment) are currently being papered over with stimulus. The Chinese economy is tilted towards goods production and less on services, also benefiting GDP.

The ECB has just expanded its pandemic emergency purchase program (PEPP) by €500 billion to a total of €1,850 billion and extended the horizon to at least the end of March 2022.¹ The United Kingdom will begin 2021 with a fresh start on trade and will freely negotiate trade agreements on its own. In January, the EU’s Common External Tariff will be replaced with the U.K. Global Tariff, which will apply to imported goods from countries without an existing trade agreement.

In December, the U.S. Federal Reserve decided to maintain the target range for the federal funds rate at 0.00% to 0.25%.² The Fed will continue to increase its holdings of Treasury securities by at least US$80B per month and of agency mortgage-backed securities by at least US$40B per month until further progress has been made toward the Fed’s maximum employment and price stability goals. Retail sales were down 1.1% in November, after falling 0.1% in October and gaining 1.7% in September.³ Regional manufacturing indexes decreased in December. Housing starts rose 1.2% in November after gaining 6.3% in October.⁴ The number of Americans filing for unemployment benefits decreased to 803,000 in the week ended December 19th, from the previous week’s three-month high of 892,000. Claims remained well above the 200,000 level reported back in February.⁵ The Canadian real GDP surprised mildly to the high side of expectations with a 0.4% advance in October.⁶

Global equities posted their highest monthly return since the turn of the century in November. All 50 countries included in the global benchmark gained as prospects for overcoming COVID-19 considerably improved. U.S. markets saw their best performance since April. The S&P 500 gained 10.9% while smaller caps outperformed, with the S&P MidCap 400 and S&P SmallCap 600 rising 14.3% and 18.2%, respectively. Canadian equities posted strong performance in November, with the S&P/TSX Composite up 10.6%. European equities surged in November. The S&P Europe 350 had its best month ever, posting a total return of 14.2%. The S&P United Kingdom gained 13.3% as investors brushed off the fast-approaching year-end deadline for a trade agreement with the E.U. to avoid a no-deal exit from the trading bloc. Asian equities soared in November, with the S&P Pan Asia BMI up 10.4%. S&P Singapore BMI led the group up 15.2%, followed by S&P Korea BMI up 14.6%. Investment demand for gold via ETFs remains strong while gold has returned more than 20% in 2020 as of December 28.

In December, we maintained the asset allocation that was established in November for all models. We continue to favor shorter duration fixed income. With interest rates low or negative, we have maintained exposure to gold. Equity exposure across all models reflects our view that markets are looking through the uncertainty of the pandemic and towards the resumption of more normal life once the population is vaccinated.

We are closing in on the end of a year that introduced the current global pandemic, triggering the deepest global economic setback of the post-war era, record joblessness in North America, second and third virus waves, U.S. civil unrest, a near-war with Iran, trade and tech tensions with China, a Russian hack, Brexit uncertainty (again), and an endless U.S. election cycle that then required four days to declare a winner. The pandemic is unfortunately not over as we enter 2021. Our approach to portfolio management is nimble, opportunistic, and deliberate in identifying asset classes that are best placed to generate returns in a new world order. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame, President and CIO

 

¹ Trading Economics. ECP Emergency Purchase Program. December 10, 2020.

² Trading Economics. U.S. Fed Funds Rate. December 16, 2020.

³ Trading Economics. U.S. Retail Sales. December 16, 2020.

⁴ Trading Economics. U.S. Housing Starts. December 17, 2020.

⁵ Trading Economics. U.S. Unemployment. December 4, 2020.

⁶ Trading Economics. Canada GDP Month over Month. December 23, 2020.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. November 30, 2020. Index performance is based on total returns and expressed in the local currency of the index.

 

 

Today, COVID-19 is no longer the unknown but the new normal and is spreading again in the U.S. and Europe. The combination of caution and restrictions on travel and hospitality continue to impede the recovery. The reopening of economies that began in May will contribute to GDP recovery, but a second wave of virus infections have been followed by localized restrictions on activity. Concern about the resurgence of the virus may well restrain demand and activity as businesses are unlikely to invest in capital spending without greater certainty and/or tax incentives. Consumers will be cautious until personal safety and employment certainty are evident, so stimulus may be muted. As a result, post-pandemic deflation is likely.

China is already achieving levels of economic activity that exceed the pre-COVID period in many sectors. This is led by exports at +9.9% y/y growth in dollar terms in September, fueled by some catch-up after first half disruptions. Industrial production was +5.6% y/y growth in August, and retail sales edged into positive territory.¹ In the UK, Brexit concerns are once again returning as the negotiations between the EU and the UK remain deadlocked. The UK saw one of the largest declines in GDP in Q2 (-19.8%) compared to its peers.² Eurozone activity rebounded sharply as economies reopened in May and June.  Second waves of the virus, especially severe in France and Spain, are hurting sentiment and highlight downside risks to recovery.

The November 3rd U.S. election hangs in the balance, with the threat of a contested election looming. Coronavirus is the most significant risk, but political uncertainty is also elevated. Lawmakers have failed to agree on another stimulus package, despite Fed Chair Powell’s repeated calls for additional fiscal help. Polls show a growing lead for Biden but potential delays in determining results and questions around a smooth transition of power could see uncertainty persist beyond November 3rd. Last month, we noted the Federal Reserve would no longer pre-emptively increase rates to cool higher inflation, and this monetary policy philosophy could trickle into other regions. This appears to have happened following the ECB’s announcement that it may consider allowing inflation to run higher for longer than usual. US dollar depreciation has been a significant trend in markets over the last few months. Historically, changes in USD have had a countercyclical relationship to global growth. There are several other longer-term factors that continue to support the recent decline. Yield compression and equity outperformance weakened the relative attractiveness of USD assets and reduced the cost of hedging for foreign holdings of USD assets. In Canada, extension of government support for households was enough for the minority Liberals to avoid a fall election. The Bank of Canada is expected to remain dovish, keeping rates at 0.25% and continuing the asset purchase program until the recovery is well underway.

Despite a slump in September, U.S. equities managed to gain over the quarter. The S&P 500 gained 8.9%, while the S&P MidCap 400 and the S&P SmallCap 600 gained 4.8% and 3.2%, respectively. Despite September’s retrenchment, Canadian equities gained in Q3, with the S&P/TSX Composite up 4.7%. Following an up and down month driven by an increase in regional COVID-19 cases, European equities declined 1.5% in September and finished Q3 down 0.03%. Continued struggles from large British banks also weighed on the S&P United Kingdom, which declined 1.7% in September and 4.8% for Q3. Asian equities ended Q3 up, with the S&P Pan Asia BMI gaining 8.9%. Most single-country indices posted quarterly gains, with Korea in the lead, up 11.5%. Gold was one of several major assets that started the quarter strong, reversed in September, but closed the quarter higher. Gold’s 3.6% September pullback was likely tactical in nature. Liquidity demands often result in Gold ETF selling as they are a highly liquid option to raise cash. Gold rallied sharply (22%) between April and July, reaching an all-time high in early August, mirrored by a stronger US dollar that finished the quarter nearly 4% lower.

In October, we maintained the asset allocations established in September. We continue to be positioned in shorter duration fixed income due to larger-than-average duration supply from the Fed. Lower rates mean lower income as inflation is positively correlated to yields. With interest rates low or negative, we maintained exposure to gold. Equity exposure to large cap reflects our view that shifting business models during this pandemic have had a negative impact on bottom lines but that select businesses are benefiting from the shift. We are continuing to monitor the recovery in Europe following the Eurozone’s agreement on a stimulus package.

Until a vaccine is available, economies continue to search for the new normal. There are numerous potential catalysts for market volatility in Q4, including a contested U.S. election result, a delayed stimulus bill, a no-Brexit scenario resulting in disrupted trade in the region, and rising global virus cases. Our approach to portfolio management is nimble, opportunistic, and deliberate in identifying asset classes that are best placed to generate returns in a new world order. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame , President and CIO

 

¹ Trading Economics. China Exports. October 13, 2020.

² Trading Economics. UK GDP. September 30, 2020.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. September 30, 2020. Index performance is based on total returns and expressed in the local currency of the index.

 

 

The initial pick-up in economic activity that we saw in June began to fade in July as households and firms remained in cautious mode, particularly with new virus cases rising in some countries. Monetary policy is less effective as global interest rates are at their lowest levels, leaving central banks with little ammunition.  Central banks are conducting quantitative easing on a much larger scale than during the global financial crisis, buy­ing a wider variety of assets. In August, we maintained the Recession Outlook for our twelve- month forward time horizon.

The global pandemic has exacerbated long standing tensions between the U.S. and China, as trade, technology, and investment act as accelerators towards increased protectionism and re-onshoring. The CPB World Trade Monitor recorded a contraction of -1.1% in May and -17% for the first five months of 2020. Labor market disruptions would also keep growth potential slow as even countries that have provided ample labor market support continue to see reduced immigration, high unemployment levels, and permanent job losses.

China, Vietnam, Taiwan, and Korea are furthest along the road to recovery while economies in southern Europe, Latin America, and Africa lag behind. China has returned to growth, reporting GDP growth of 11.5% YOY for Q2 of 2020, after a contraction of -10% in Q1.¹

 Eurozone GDP results showed that their economy shrank 12.1% during Q2, the worst result on record, highlighting the economic challenges that Europe faced during lockdown.² During Q2, Spain’s GDP contracted sharply by 18.5% while Germany saw a lower infection rate and was able to relax restrictions sooner, resulting in a relatively moderate 10% decline.^3,4 On July 21, the leaders of the European Union agreed on a COVID-19 rescue package, providing €750 billion in additional aid, consisting of €390 billion in grants to replenish member-country coffers and €360 billion in loans.⁵ This is a significant step forward for the EU, as it marks the first time the bloc has raised debt in common. In the U.K., recovery has been slow and the unwinding of the furlough scheme from August is likely to prompt a second wave of unemployment. Additional uncertainty around Brexit is expected to dampen business investment further.

The economic recovery in the United States was strong in May and June, with several indicators beating expectations. It stalled in July, with a report from the Department of Labor showing initial jobless claims rising for the first time since March. Despite ongoing government support, 42% of job losses in the U.S. may be permanent, which means out of the 41 million Americans that have filed for jobless claims, at least 17 million will have no job to return to.⁶ According to the CBO, the federal budget deficit reached $2.8 trillion for the first 10 months of fiscal year 2020, $1.9 trillion more than recorded during the same period last year. In Canada, greater reliance on commodities and higher private sector debt will likely impede GDP recovery to its pre-virus level.

U.S. equities continued their rally in July. The gap between what is happening in the real world and financial markets is wide. Risks associated with weak macroeconomic data and fears of a resurgence of COVID-19 have been diminished by Fed stimulus and strong earnings results. For July, the S&P 500 gained by 5.6%, while S&P MidCap 400 and S&P SmallCap 600 gained 4.6% and 4.1%, respectively. The S&P 500 gained 2.4% for the year ending July. In Canada, the S&P/TSX Composite was up 4.5% in July. International markets also gained, with the S&P China 500 up 9.8% and the S&P Hong Kong BMI up 0.7%. European equities ended July negative as the S&P Europe 350 declined 1.5% and S&P United Kingdom declined 4.6%.

In August, we maintained the asset allocation that was established in July for all models. We continue to be positioned in shorter duration fixed income. We expect interest rates to remain low or negative across the globe and as a result, we have maintained exposure to gold while monitoring four variables: the US dollar, stock market volatility, real interest rates, and inflation. Equity exposure to large cap across all models reflects our view that shifting business models during this pandemic have had a negative impact on bottom lines but that select businesses are benefiting from the shift. We continue monitoring the recovery in Europe following the Eurozone’s agreement on a stimulus package.

While deflation caused by current weak demand is a near-term risk, current fiscal and monetary stimulus measures will likely result in inflation in the future. We continue to monitor developments regarding deficits, government intervention and regulation, reduced globalization, and greater taxation. Our approach to portfolio management is nimble, opportunistic, and deliberate in identifying asset classes that are best placed to generate returns in a new world order. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame, President and CIO

 

¹ Trading Economics. China GDP. July 16, 2020.

² Trading Economics. Eurozone GDP. August 14, 2020.

³ Trading Economics. Spain GDP. July 31, 2020.

⁴ Trading Economics. Germany GDP. July 30, 2020.

⁵ Special European Council. EU Budget. July 17-21, 2020.

⁶ TD Economics. The Post-Pandemic Global Economy. June 4, 2020.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. July 31, 2020. Index performance is based on total returns and expressed in the local currency of the index.

 

 

The role of the financial industry as an allocator and distributor of capital to the economy is critical to the evolution of the current pandemic. The current health crisis has morphed into an economic crisis, which has morphed into a financial crisis. While advances in testing and contact tracing will help, risk of a second wave of infections and the re-imposition of strict containment measures is likely to remain until a vaccine is developed. Simultaneously, geopolitical risks are heating up amid escalating tensions over Hong Kong, civil unrest in the U.S. and the return of Brexit uncertainty. We are monitoring these developments and have maintained our previous Recession outlook for the U.S. economy to reflect a Recession that began in March and extends through the end of the year.

Central banks globally have taken action. The China National People’s Congress (NPC) has laid out plans for fiscal stimulus. Japan’s fiscal support measures turned out to be larger than initially planned, at 22% of GDP.¹ The European Central Bank announced €750B in stimulus grants and loans to be funded by the currency area’s first joint debt.² The 17.1% month over month collapse in eurozone industrial output in April was partly reversed in May and June, but the recovery will be much more gradual than the slump.³ In the U.K., GDP figures for April showed that output fell by a cumulative 25% since its pre-crisis peak in February.⁴

The FOMC minutes reinforced the Fed’s commitment, putting floors on risk markets. The Fed has moved to the outer limits of monetary intervention to backstop CMBS, investment grade bonds, the muni market, and high yield debt. The Fed’s balance sheet has expanded more in three months than it did cumulatively in the six-year period from December 2007 to November 2013.⁵ The U.S. international trade deficit widened to $49.4 billion in April as exports slumped.⁶ The closure of motor vehicle production plants throughout North America had the greatest impact on the slump. Retail sales plummeted in April, down 16.4%, a 21.6% year-over-year decline but began to recover in May (up 17.7%) as thousands of stores and restaurants reopened after lockdowns and federal stimulus checks and tax refunds fueled a burst of spending.⁷ The permanent devastating impact on the economy can be seen in retail bankruptcy filings, as retailers J.C. Penney, J. Crew, and Neiman Marcus declared bankruptcy, and Lord & Taylor plans to liquidate.⁸ Unemployment was 14.7% in April, followed by an improvement in May to 13.3% as 2.5 million jobs were added back to the nonfarm employment.⁹

Statistics Canada announced that the services trade balance jumped from a deficit of $1.1 billion in March to a surplus of $0.3bn in April, reflecting that more Canadians travel abroad than foreigners travel to Canada.¹⁰

Markets during May were driven by some positive data and reopening plans. The S&P 500 closed up 4.8% for the month. The S&P MidCap 400 gained 7.3% and S&P SmallCap 600 gained 4.3%. Canadian equities had a positive month, with the S&P/TSX Composite up 3.0%. S&P Europe 350 gained 2.9% as contributing nations unlocked at differing speeds with German equities providing the greatest positive contribution. Asian equities continued their recovery, with the S&P Pan Asia BMI up 3.0%. S&P China 500 gained 1.0%, S&P Korea BMI was up 4.8%, while S&P Hong Kong BMI dropped 7.8% in May.

In June, we maintained the asset allocation that was established in May for all portfolio models. We continue to be positioned in shorter duration fixed income. We expect interest rates to remain low or negative across the globe and as a result, we continue to have exposure to gold which is a store of value in this environment and a preferred asset for central banks for the foreseeable future. Equity exposure to large cap across all models reflects our view that shifting business models during this pandemic have had a negative impact on bottom lines but that select businesses are benefiting from the shift.

The scale of the economic damage caused by the coronavirus outbreak will lead to an extended period of weak economic growth, excess capacity, deflationary pressure, and a wave of bankruptcies. Financial repression is likely to remain through our outlook time horizon (the next twelve months) as central banks continue to demonstrate their willingness to keep widening their safety net. We will continue to monitor the data for growth, inflation, and recession signals from employment, consumer spending, business sentiment, Fed policy, the yield curve, inflation, and global economics. Our approach to portfolio management is nimble, opportunistic, and deliberate in identifying asset classes that are best placed to generate returns in a new world order. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame , President and CIO

 

¹KPMG Insights, Japan. April 7th, 2020.

²European Central Bank. March 18th, 2020.

³Trading Economics, Eurozone Industrial Production. April 2020.

⁴Trading Economics, United Kingdom GDP Growth. May 13th, 2020.

⁵Trading Economics, U.S. Central Bank Balance Sheet. June 10th, 2020.

⁶Trading Economics, U.S. Balance of Trade. June 4th, 2020.

⁷Trading Economics, U.S. Retail Sales. June 16th, 2020.

⁸S&P Global Market Intelligence. May 15th, 2020.

⁹Trading Economics, U.S. Unemployment Rate. June 5th, 2020.

¹⁰Trading Economics, Canada Balance of Trade. June 4th, 2020.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. May 29, 2020. Index performance is based on total returns and expressed in the local currency of the index.

 

 

The economic cost of the COVID-19 crisis may pale in comparison to the human cost. Many people fear for their own health and that of their loved ones. As such, there is a “real” element to the fear factor. Measures to contain the virus have upended supply chains and financial markets and have weighed on commodity prices. Consumer and business confidence are expected to remain subdued for some time, not least if fears of a second wave of the virus linger. We are monitoring these developments and have maintained our previous Recession outlook for the U.S. economy to reflect a Recession beginning in March and extending through the end of the year, as the situation will deteriorate further before beginning to recover.

With lockdowns in place across much of the world, the IMF has downgraded their forecasts further in recent days, now forecasting global real GDP to fall by over 3% this year. That compares with a pre-virus forecast assuming growth of about 3%. This means that 2020 is set to be the worst year for the global economy since the end of the Second World War, when world GDP in 1945 plunged by 5.5%.¹

The Fed has launched many new programs. The U.S. was on track for an outright fiscal drag in 2020 due to expiring stimulus, living with the largest fiscal deficit and thus is the least capable of delivering more fiscal stimulus. The Federal Reserve has now expanded its balance sheet beyond $6 trillion, an increase of almost $2 trillion in less than a month.² It has taken extraordinary steps to lift regulations to help banks play their part in the relief effort. One consequence may be that central bank support could help most risky assets to outperform safe ones by a wide margin as these measures go far beyond conventional monetary easing in their efforts to backstop the financial system. With a policy interest rate that has been cut to a range of 0% to 0.25% and commitment that rates would stay low indefinitely, the supply of funds outside of the Feds own money creation may become scarce. By virtue of a system that promotes superior productivity growth, the country’s knack for nurturing world-beating companies, and less challenging demographics than the developed world, there is some hope that the U.S. can outpace most of the developed world in economic recovery.

Canada will rack up debt faster in this crisis than any other developed country, relative to its economy, according to data from the IMF. It is fortunate that Canada’s governments went into this economic crisis in a much better financial position than most other developed countries. Net government debt (total government debt minus its cash holdings) was at 40% of economic output before the crisis. The average for developed countries was 107%. This may be why Canada’s governments have proven more willing to spend their way out of the crisis than some others.³

Global markets in Q1 were devastated by the coronavirus pandemic. U.S. equities posted their worst quarter since 2008, with the S&P 500 down 19.6%. The S&P MidCap 400 and the S&P SmallCap 600 were down 29.7% and 32.6%, respectively. Canadian equities were likewise battered, with the S&P/TSX Composite down 20.9% for the quarter. The Canadian Energy sector was down by 30.8% in March and 37.2% in the first quarter. The global pandemic fears also spread rapidly across Europe. Italy, and then Spain. The S&P Europe 350 fell 14.0% in March to complete a 22.4% drop this quarter, the worst monthly and quarterly performance since September 2002. International markets were not spared, and the S&P Pan Asia BMI was down by 20% for the quarter. U.S. Treasuries benefited from a flight to safety. Corporate bonds fared less well, as spreads widened across sectors and grades of the credit market.

In April, we maintained the asset allocation positioning that we established on February 19th. This reflects our view on deflationary and recessionary influences that dominate the global economy.  Allocation to equities was reduced in February to 12% in Tactical Conservative, 17% in Tactical Moderate Growth, 26% in Tactical Growth, and 34% in Tactical Aggressive Growth. In February, within the Fixed Income allocation, we added the 20+ year Treasury Bond. Gold continues to be present in all models as it performs well in high risk, low yield environments as a risk-free asset class. Gold has played an important role in portfolios as a source of liquidity and collateral. As has been the case in previous market selloffs, we have seen that the stronger the pullback in the stock market, the more negatively correlated gold becomes.

This shutdown will cause the greatest short-term drop in output that the global economy has ever experienced, and the pace of the subsequent recovery is hard to determine at this time. No one knows how long the supply and demand disruptions will constrain growth. We will continue to monitor the data for growth, inflation, and recession signals from employment, consumer spending, business sentiment, Fed policy, the yield curve, inflation, and global economics. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame, President and CIO

 

¹ Capital Economics. Global Economics Update. March 31, 2020.

² Capital Economics. U.S. Economic Update. April 16, 2020.

³ National Bank of Canada. Public Sector Debt. April 15, 2020.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. March 31, 2020. Index performance is based on total returns and expressed in the local currency of the index.