The macroeconomic outlook continues to improve, and the recovery may be faster than one that typically follows a business cycle recession, as vaccination rollouts accelerate, and the US$1.9 trillion stimulus package has been signed into law. This has prompted a surge in inflation expectations and commodity prices and a bond sell-off. The latest round of global manufacturing PMIs have flagged rising input costs, growing order back-logs, and longer supplier delivery times. Commodity prices have increased sharply as seen in Bloomberg’s commodity price index, up 17.5% from December 1st to March 1st.1 Oil prices hit their highest level in more than a year in February with WTI crossing the US$60 per barrel mark.2 Higher shipping costs and input shortages will test central banks’ commitments to keep interest rates low for an extended period as pent-up demand could outpace supply. At this point in the recovery, households have used lockdown savings to pay down debt – particularly credit cards – while holding onto cash for precautionary reasons, causing demand to be suppressed.

Our twelve-month forward outlook remains at three months of Growth, followed by nine months of Stagnation, as we have seen evidence of a stronger short-term recovery rebound but a lingering longer-term impact on employment and output.

In China, an updated analysis shows that non-financial debt as a percent of GDP jumped 23% to 281% in 2020.3 The debt spike is likely to be temporary. China’s economy returned to its pre-pandemic growth path in the fourth quarter of 2020, which triggered an earlier-than-expected normalization in credit policy. In the Asia Pacific region, Australia’s economy grew at a stronger-than-expected pace toward the end of last year with a 3.1% non-annualized gain.4

The Euro Area has been hampered by lockdowns. The continent has been slow to ramp up vaccinations, with only slightly more than 5% of the population in major European countries having received at least one dose.5 The annual core inflation rate in the Euro Area, which excludes volatile prices of energy, food, and alcohol & tobacco, and at which the ECB looks in its policy decisions, slowed to 1.1% in February, from 1.4% in January.6 The U.K. is seeing a sluggish start to the year thanks to extended lockdowns and as the Brexit deal hit trade hard in January. A relatively speedy vaccine rollout that has seen 30% of the U.K. population receive at least one dose as of early March, should help the recovery beyond the current quarter.

The US$1.9 trillion stimulus package will add significantly to households’ purchasing power. Retail sales in the U.S. shrank 3% month-over-month in February of 2021, following an upwardly revised 7.6% jump in January.7 Housing starts reached the highest rate in 14 years in December as people moved away from the big cities due to the coronavirus pandemic but sank by 10.3% month-over-month in February.8 Prices for U.S. exports rose 1.6% from a month earlier in February 2021 while import prices increased 1.3% month-over-month.9 Canada’s fourth quarter GDP rose to an annualized 9.6%. The annual inflation rate remains low at 1.1% in February. Excluding gasoline, inflation was 1.0%, down from 1.3% in January.10

Despite a sell-off in the last week of the month, U.S. equities ended February on a positive note, with the S&P 500 posting a gain of 2.8%. Smaller caps outperformed, with the S&P Mid Cap 400 and the S&P Small Cap 600 up 6.8% and 7.7%, respectively. Volatility remained high, with the VIX closing the month at 27.95. U.S. Treasury performance was negative. Canadian equities ended February strongly, with the S&P/TSX Composite up 4.4%. Despite a sharp sell-off at month end, the S&P Europe 350 finished February with a gain of 2.7%, while the S&P United Kingdom rose 1.8% in pound sterling terms. Asian equities posted gains in February, with the S&P Pan Asia BMI up 1.7%. Government bonds sold off in February as investors digested a confluence of factors that look set to push inflation higher and could test central banks’ commitments to keep interest rates low for an extended period.

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 populations are vaccinated. In March, we maintained the asset allocation that we established in February. We continue to include some exposure to gold as a stabilizer in this volatile environment. Shorter duration fixed income has been maintained as the U.S. economy normalizes and inflationary pressures are rising.

The economic reopening and the global stimulus that is underway will lead to improved household liquidity, a wealth effect from rising asset values and lower consumption, healthy consumer balance sheets, and a healing labor market. 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 BCOM Index. December 1 to March 1, 2021.

2 Bloomberg WTI Index. February 21, 2021.

3 Trading Economics. China Debt, BIS Statistics. March 2021.

4 Trading Economics. Australia GDP. March 3, 2021.

5 European Centre for Disease Prevention and Control. March 17, 2021.

6 Trading Economics. Euro Area Inflation. March 17, 2021.

7 Trading Economics. U.S. Retail Sales. March 17, 2021.

8 Trading Economics. U.S. Housing Starts. March 16, 2021.

9 Trading Economics. U.S. Trade. March 17, 2021.

10 Trading Economics. Canada Inflation. March 17, 2021.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. February 28, 2021. Index performance is based on total returns and expressed in the local currency of the index.

 

 

The global economy has experienced a type of regime shift in response to the pandemic, and the recovery that follows will not be typical of historic recoveries following periods of recession and stagnation. Since the pandemic began, our outlook has been influenced by virus-related developments and fiscal stimulus, with consumer spending particularly sensitive to changes in these developments.  With our focus on this, we have changed our current twelve-month forward outlook to three months of Growth, followed by nine months of Stagnation, as we have seen evidence of a stronger recovery rebound since the start of the year.

Governments around the world are signaling that they will maintain fiscal support, with the U.S. administration set to lead the way by turning its attention to a multi-year infrastructure package. At the same time, major central banks are expressing a willingness to maintain accommodative stances despite a near-term inflation bounce, as they encourage an inflation overshoot and a rebound in inflation expectations. Incoming reports raise estimates of global GDP growth to 4% in 2021.1

China’s current account surplus widened to 2.0% of GDP in 2020, amounting to US$298.9 billion, compared to US$141.3 billion (1.0% of GDP) in 2019.2 On the merchandise trade front, China’s export sector was boosted by PPE and tech-related products. The steep decline in oil prices also cut China’s import bill by US$67.8 billion (or 26.5%) in 2020.3 In Western Europe, industrial activity and construction have continued to expand even as a weak service sector depresses GDP. Strong manufacturing is largely driven by the export-oriented German economy, where the manufacturing output index jumped 3.2%.4

In the U.S., the new stimulus package should boost an economy that is already off to a better-than-expected start to the year. The U.S. earnings season has been very strong, with the Q4 2020 earnings growth rate for the S&P 500 at 3.9%.5 Retail sales surged 5.3% in January.6 Manufacturing output continued to climb rapidly through January and most housing indicators showed strong levels of activity.  The Canadian economy (outside of the hospitality sector) continued to show resilience through the second wave of lockdowns as households and businesses adapted to tighter restrictions and the number of new COVID-19 cases continues to trend down. Retail sales were impacted by new containment measures but have remained resilient relative to the collapse in the spring. Manufacturing has been less severely impacted by the second wave of lockdowns with sales gradually converging back towards year-ago levels.

Global central banks have effectively taken interest rates to zero, driving nearly all sovereign debt to negative real yields. With less opportunity for yield across fixed income assets – especially those of shorter duration or higher quality – investors will likely continue to shift exposure to riskier assets. The S&P 500 posted a loss for January of 1.01%. Smaller caps outperformed, with the S&P MidCap 400 and the S&P SmallCap 600 up 1.5% and 6.3%, respectively. U.S. fixed income performance was mostly negative, particularly in corporates. Canadian equities posted losses, with the S&P/TSX Composite down 0.3%. The S&P Europe 350 erased its gains in the final day of January, leaving the continental benchmark with a total return of -0.8%. The S&P United Kingdom was down 0.6%. Asian equities began 2021 strongly. The S&P China 500 was up 4.8% and the S&P Hong Kong BMI was up 3.4%. Australian equities managed a gain with the S&P/ASX 200 up 0.3%, continuing a recent strong run which has seen it gain 12% over the last three months.

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 populations are vaccinated. In February, we shifted a portion of the gold exposure into U.S. Midcap Equities to reflect the updated outlook to near-term growth. Across the Conservative, Moderate Growth, Growth, and Aggressive Growth models, we added 8%, 10%, 12%, and 14% respectively. We continue to include some exposure to gold as a stabilizer in this volatile environment. Shorter duration fixed income has been maintained as the U.S. economy normalizes and inflationary pressures are rising.

The economic reopening and the global stimulus that is underway will lead to improved household liquidity, a wealth effect from rising asset values and lower consumption, healthy consumer balance sheets, and a healing labor market. 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 World Bank. Global Economic Prospects. January 2021.

2 Trading Economics. China Current Account. January 2021.

3 Trading Economics. China Imports. January 2021.

4 Trading Economics. Germany Exports. January 2021.

5 FactSet. Earnings Insight. February 26, 2021.

6 Trading Economics. U.S. Retail Sales. February 17, 2021.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. January 29, 2021. Index performance is based on total returns and expressed in the local currency of the index.

 

 

The global economy remains dominated by the global pandemic. While the world was hoping to see a conclusion with the launch of vaccines as we entered 2021, rising COVID-19 cases and a more infectious new variant of the virus have created a renewed sense of caution. There have been over 94 million documented cases of COVID-19 and over 2 million deaths reported globally.1 The global economy has been plunged into its deepest recession since the Second World War. A combination of fiscal and monetary policy support will generate growth recovery, but we are maintaining our twelve-month forward forecast of Recession as we do not yet see the recovery overtaking the negative impact of the pandemic that currently prevails.

Growth in China decelerated to an estimated 2.3% in 2020 – the slowest pace since 1976.2 The recovery has been uneven as import growth lagged a rebound in exports, contributing to a widening current account surplus. Accommodative fiscal and monetary policies have resulted in an increase in the government deficit and total debt.3 The Euro area and U.K. economies are projected to contract as they implement more expansive lockdown measures, with sectors like tourism likely to remain depressed. Euro area consumer confidence dropped 1.6 pts to -15.5 in January, which left the survey low by historical standards.4

The U.S. economy is stronger than most other global economies while it continues to experience an uneven recovery. The fall in U.S. activity in the first half of 2020 was nearly three times as large as the peak decline during the global financial crisis, underscoring the depth of the recession.5 Substantial fiscal support to household incomes – far exceeding similar measures delivered during the global financial crisis – contributed to a robust initial rebound in the third quarter of 2020, which was subsequently cut short by a broad resurgence of the pandemic. In Canada, COVID-19-related metrics have been improving and vaccines continue to be rolled out. The Bank of Canada kept all aspects of monetary policy unchanged in January, including the policy rate (0.25%), C$4 billion weekly QE program, and the outcome-based forward guidance.

Despite the COVID-19 pandemic and the uncertainty of an election year, U.S. equities ended the year with the S&P 500 posting a gain of 18.4% for 2020. Smaller caps reversed course by outperforming in Q4, with the S&P MidCap 400 and S&P SmallCap 600 up 13.7% and 11.3% for the year, respectively. Canadian equities ended the year with modest gains, with the S&P/TSX Composite up 5.6% for 2020. European equities finished 2020 down 2.8% thanks to the United Kingdom, down 12.9% after agreeing to “Brexit”. The S&P Europe 350’s total return would have been a 2% gain were it not for the negative contribution of British stocks. The Euro gained 6% versus sterling and 8% vs the US Dollar during 2020. Asian equities recovered after being devastated by COVID-19 in March, with the S&P Pan Asia BMI up 20% for the year. All Asian single-country indices posted gains, with Korea and Taiwan in the lead. Rates on both sides of the Atlantic fell, pushing major sovereign yields further into negative territory across the Eurozone. European bonds outperformed equities, with risker credits top of the performance charts. U.K. bonds also performed well, more in local terms than euros.

In January, we maintained the asset allocation that was established in December for all models. Within Equities, we eliminated our position in U.S. MidCap Equities in the Growth and Aggressive Growth models and established a position in Australian Equities to replace it as the COVID-19 vaccine is being rolled out there quickly, the Government and Reserve Bank are pumping more stimulus into the economy, and the hardest-hit sectors are making a recovery. 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 continue to favor shorter duration fixed income. With interest rates low or negative, we have maintained exposure to gold.

The COVID-19 pandemic is a global crisis that necessitates a coordinated global response. It is likely to steepen the slowdown in potential growth, undermining prospects for labor productivity and poverty reduction. Limiting the spread of the virus, providing relief for vulnerable populations, and overcoming vaccine-related challenges are immediate priorities. Only when the pandemic is effectively managed in all countries will individual countries be safe from resurgence, allowing global growth outcomes to improve materially. 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

 

Johns Hopkins University. National Public Health Agencies. January 18, 2021.

Trading Economics. China GDP. December 2020.

The World Bank. 2021 Global Economic Prospects. January 2021 (figures 1.10.C and 1.10.D).

Trading Economics. Euro Consumer Confidence. January 21, 2021.

Trading Economics. U.S. GDP Growth Rate. January 2021.

 

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

 

 

Section 1: Q1 2021 Outlook

 

We Expect an Uneven Recovery and a Prolonged Global Recession

While the world was hoping to see the conclusion of the global pandemic as we entered 2021, instead, we find ourselves more in the middle of the cycle. The pandemic has plunged the global economy into its deepest recession since the Second World War, killing millions and freezing economies across multiple continents. As we enter 2021, there have been over 94 million documented cases of COVID 19 and over 2 million deaths reported globally.i

The impact of weakened fundamental drivers of growth, will steepen the slowdown in labor productivity over the next decade. The pandemic is likely to steepen the long-expected slowdown in potential growth, undermining prospects for labor productivity and poverty reduction. Limiting the spread of the virus, providing relief for vulnerable populations, and overcoming vaccine-related challenges are key immediate priorities.

International bodies, such as the World Health Organization and the Group of Seven, that had been relied upon for a game plan to coordinate a global attack on a global pandemic, proved to be incapable of delivering. Adding to the disaster has been the propensity for the gaps in scientists’ understanding of COVID-19 that have been filled by opportunists.

 

2020: Teetering Between Recovery and Chaos

From the early months of the pandemic in the spring of 2020, the nature of exponential growth of infections led to a doubling every five or six days. A majority of countries failed to anticipate how they would deal with the spread. Italy’s advanced health-care system collapsed under the burden of cases in March as other countries delayed. Britain went into lockdown two weeks after Italy. During that time infections multiplied between four and eight times. In contrast, Asian countries, such as Taiwan, Singapore, and Vietnam drew on their experience of earlier coronaviruses and acted early and effectively.

Entering April, in response to the global spread, the world underwent a de-globalization as borders closed and travel virtually ceased. And as anticipated, a second wave that was more rampant than the first wave of the virus occurred in the fall. Despite having had months to prepare, governments failed to see the crisis coming for a second time.

Moving forward, the vaccine is a game-changer, allowing restrictions to begin to be lifted. The news of a rollout in record time has brought hope to the situation. The most immediate risk is that the rollout of vaccines is slower than the spread of the virus, held back by bottlenecks in production, or more likely, distribution and administration. As of December 30th, 2.8 million doses of vaccine had been administered in the U.S., a rate at which it will take four full years to vaccinate the entire population. Hopefully this will change as supply chain issues are ironed out and the incoming Biden Administration takes a much more proactive stance. Assuming that there is no virus mutation, by the end of 2021 it is hoped that much of the Western population will have been vaccinated. Western economies can only then begin to return to their long-term trend growth.

 

Underlying Geopolitical Challenges

2020 saw the deepest global economic setback of the post-war era. Political dysfunction became a way of life in the U.S. and elsewhere. Record joblessness in North America, second and third virus waves, U.S. civil unrest, a near-war with Iran, simmering 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 are notable events that followed a profoundly traumatic decade. Underlying challenges were made worse by the economic stress caused by the virus.

• Democracy receded from the heights of the post-Cold War era, retreating in more places than it advanced,
• Brexit and surging populism threatened European integration, one of the defining endeavors of the post-World War II era,
• Globalization encountered fierce political and geopolitical headwinds, as the World Trade Organization become gridlocked,
• China’s economic rise grew more ominous, and
• America became an uncertain advocate of free trade.

COVID-19 is expected to increase global inequality, both within and between countries.

Within countries, the pandemic has hit lower-paid workers particularly hard – the informally employed, women, immigrants, and the low-skilled. Lower-income workers tend to be less able to work from home than higher-income workers and are more likely to be exposed to the pandemic at work and are more vulnerable to job or income losses due to lockdowns.ii The share of lower-paid workers is higher in essential services where workers are more exposed to the pandemic. Social benefits may fail to reach middle income households that have suffered income losses but are outside existing poverty alleviation programs.iii

With regard to inequality between countries, lower-income countries tend to have large informal sectors that concentrate in activities, and operate in facilities, that require close interactions and are particularly vulnerable to pandemic-related disruptions. In addition to causing losses in output levels, the pandemic has set back fundamental drivers of long-term output growth – investment, improvements in education and health, and increases in female labor force participation. Weakening fundamental drivers of growth will be reflected in lower potential growth prospects over the 2020s.

 

Government Debt and Fiscal Policy Risks

A number of risks related to the pandemic will add to the collateral damage and make the recovery more uneven. These include the rising debt levels in global economies as well as the debt resulting at the corporate level as pandemic related weakness impacts many sectors.

When COVID-19 first began to spread around the world in the spring of 2020, this health emergency risked triggering an economic and financial crisis. America’s financial mechanisms froze as companies scrambled for cash, dumping even their holdings of usually safe Treasuries. Companies and investors the world over rushed into dollars. The bottom fell out of the oil market as demand collapsed. In April the futures price for West Texas Intermediate crude went negative, declining to -$37 per barrel.

As countries locked down, they experienced their deepest downturns in recent memory. But financial panic was averted. The banks stayed resilient. Part of that is a consequence of regulation after the global financial crisis. Fiscal stimulus, government credit guarantees, and central bank action have prevented many losses from occurring. The Federal Reserve stepped into Treasury and corporate-bond markets, a sign of the growing importance of capital markets as a source of credit. The stimulus helped Wall Street, even as Main Street suffered. By August, and again towards the end of the year, the S&P 500 stock market index was hitting record highs. The exuberance was at first concentrated around the sorts of companies, such as those in tech and health care, that did well out of the pandemic. But as news of an effective vaccine broke in early November, it rippled out to emerging markets.

The pandemic has exacerbated the risks to Main Street associated with a decade-long wave of global debt accumulation. Debt levels have reached historic highs, making the global economy particularly vulnerable to financial market stress. There is now almost universal agreement among governments and central banks over the need to maintain fiscal and monetary support until recoveries are entrenched. As a result of sharp output collapses, unprecedented policy stimulus across global economies has led to debt-to-GDP ratios that are set to reach new highs. Global government debt is expected to have reached 99 percent of GDP for the first time on record in 2020.iv

The COVID-19 pandemic is likely to deepen and prolong a slowdown in output, productivity, and investment growth that has been underway for a decade. Weak growth will further increase debt burdens and erode borrowers’ ability to service debt. For some countries in debt distress, the economic outlook may only improve once debt relief via debt write-offs occurs, rather than rescheduling. Pre-emptive debt restructurings have generally been associated with better macroeconomic outcomes rather than restructurings that occur after a default has occurred.v

2020 fiscal easing outstrips 2009 although the amount varies across regions, resulting in divergent growth. Among Emerging Market and Developing Economies (EMDEs), total debt had risen by about 7 percentage points of GDP each year since 2009. In 2020, government debt alone is expected to rise by 9 percentage points of GDP, the most since a series of late 1980s debt crises while corporate indebtedness is also likely to sharply increase.vi

The pandemic has made this wave of debt more dangerous by increasing its risky features. The sheer magnitude and speed of the debt buildup heightens the risk that not all of it will be used for productive purposes. Previous waves of debt have ended with widespread financial crises. When debt resolution was protracted, growth was often slow to recover or even resulted in a lost decade of growth. There is a risk that this fourth wave of debt since 1970, like its predecessors, also ends with a major financial crisis, with some countries already experiencing debt distress.

Since 1970, about half of all countries that experienced a rapid buildup of debt also experienced a financial crisis. Where debt accumulation episodes were accompanied by crises, output and investment were significantly lower even several years after the end of the episode than in countries without crises.vii

A different but related risk is that ultra-loose monetary policies have led to a misallocation of capital that ultimately threatens the stability of the financial system in one or several major economies. This is possible – history shows how a combination of easy money and liberalized capital markets can cause asset price bubbles to inflate, which can then cause economic and financial market dislocation when they burst. This process typically plays out over years. While it is worth keeping at least one eye on China’s property market, we think that the valuation of major asset classes (including equities) can for now be justified in the context of lower interest rates.

 

Uneven Economic Recovery in 2021

Although the global economy is emerging from the collapse triggered by COVID-19, the recovery is expected to be slow and global GDP is expected to remain below pre-pandemic levels for all of 2021 and 2022. Recessions that feature financial crises are significantly deeper and longer than recessions that do not.viii Against this backdrop, widespread financial crises, combined with a prolonged pandemic and delayed vaccination, could result in a double-dip global recession, with a further contraction in activity this year.

Throughout the second half of 2020, world trade rebounded strongly. The recovery to date has largely played out in the goods economy much more than in services, as consumers can carry on with purchases from home while other activities requiring face-to-face interactions, such as leisure and travel, are more challenging to resume.

According to the World Bank Global Economic Prospects, published in January 2021, the World Bank projects global economic output to expand 4% in 2021 but remain more than 5% below its pre-pandemic trend. They also project global trade volume growth at 5% in 2021 following a 9.5% contraction in 2020.

Global growth is projected to moderate to 3.8% in 2022, weighed down by the pandemic’s lasting damage to potential growth. In particular, the impact of the pandemic on investment and human capital is expected to erode growth prospects in emerging market and developing economies (EMDEs) and set back key development goals.

In the baseline scenario, global output in 2025 would be about 5% below the pre-pandemic trend and there would be a cumulative output loss during 2020-25 equivalent to 36% of 2019 global GDP.

In addition to causing losses in output levels, the pandemic has set back fundamental drivers of long-term output growth – investment, improvements in education and health, and increases in female labor force participation. Weakening fundamental drivers of growth will be reflected in lower potential growth prospects over the 2020s. The World Bank projects global potential growth would slow by another 0.3 percentage points a year compared with pre pandemic trends, to 1.9% a year over 2020- 29, below the 2.1% a year expected before the pandemic.

 

Global Prospects

SOURCES: COVID-19 COMMUNITY MOBILITY REPORTS (DATABASE); HAVER ANALYTICS; OUR WORLD IN
DATA (DATABASE); WORLD BANK.

 

Like human capital accumulation, infrastructure investment raises growth directly by increasing the capital stock and indirectly through its collateral benefits for productivity. Good infrastructure investment can raise productivity by improving competitiveness, lowering production costs, facilitating trade, strengthening human capital, and encouraging innovation and knowledge diffusion. For example, better transportation networks can reduce the cost and time of new construction and installation of new equipment, and improved access to electricity and better sanitation can raise educational attainment and public health standards.

The World Bank Global Economic Prospects Report includes two adverse scenarios; one where new infections remain elevated in much of the world, and a second where vaccination delays re-ignite financial stress that spurs widespread corporate and sovereign defaults. Such outcomes could mean just 1.6% growth this year or even another global contraction.

A more prolific pandemic could lead to even larger income losses. In a downside scenario of persistently higher caseloads and delayed vaccination, global output in 2025 would be about 8% below earlier expectations, and there would be a cumulative loss equivalent to 54% of 2019 global output. Delays in vaccine deployment could disappoint financial markets and trigger a repricing of risks. Amid record-high debt, higher borrowing costs could tip many firms into bankruptcy, weakening bank balance sheets, possibly to an extent that could trigger a financial crisis. In such a severe downside scenario, the report projects that global output could contract by another 0.7% in 2021. Cumulative output losses over 2020-25 could amount to 68% of 2019 output globally.

The International Monetary Fund in October slightly lowered its 2021 growth forecast to 5.2%, warning that despite massive stimulus from central banks and governments the world still faces an uneven recovery until the virus is tamed.

 

Country Level Outlook

The U.S. economy remains stronger than most other global economies. The fall in U.S. activity in the first half of 2020 was nearly three times as large as the peak decline during the global financial crisis, underscoring the depth of the recession. For 2020, U.S. output is estimated to have fallen by 3.6%. Although the pandemic’s economic impact was not as severe as envisioned in previous projections, last year’s contraction was more than one percentage point larger than that of 2009.

Substantial fiscal support to household incomes – far exceeding similar measures delivered during the global financial crisis – contributed to a robust initial rebound in the third quarter of 2020, which was subsequently cut short by a broad resurgence of the pandemic. The 2021 U.S. growth forecast was cut to 3.5% from 4% in June on subdued demand seen in the early part of the year amid new restrictions and a broad virus resurgence.ix

The near-term outlook for other countries including Canada remains clouded by the resurgence in infections and lockdown measures which are weighing heavily on economic activity. While Canada and the U.S. are expected to cross the finish line of 2020 with gains, the Euro area and U.K. economies are projected to contract given more expansive lockdown measures. Substantial monetary and fiscal policy support will underpin modest growth in all four economies in early 2021 with the momentum building as more people are vaccinated, restrictions ease, and confidence improves.

Other highlights from the World Bank report include:

• Euro area projection reduced to 3.6% from 4.5% following stringent lockdowns, with sectors like tourism likely to remain depressed.
• Latin America estimate raised to 3.7% from 2.8% on prospects for restrictions easing, faster vaccinations in the second half, and rising oil and metal prices.
• Many emerging countries had less fiscal room to offer big handouts and as a consequence may suffer greater economic damage.
• Subdued demand and heightened economic uncertainty, combined with disruptions to schooling and employment, are weighing heavily on labor productivity.

 

Conclusion

The history of the pandemic has been one of hope over experience, with governments anticipating that lockdowns will be short-lived but then retreating as the virus spreads in ways that we failed to envisage.

Policy support from both central banks and governments will eventually lead to the transition to a sustainable recovery. With weak fiscal positions severely constraining government support measures in many countries, it will be a challenge to recover with sustainable and equitable growth.

The COVID-19 pandemic is a global crisis that necessitates a coordinated global response. Only when the pandemic is effectively managed in all countries will individual countries be safe from resurgence, allowing global growth outcomes to improve materially. We expect emerging markets will continue to outpace advanced economies.

Global cooperation is critical in addressing many of these challenges. The global community needs to make sure the ongoing debt wave does not end with a string of debt crises in EMDEs, as was the case with earlier waves of debt accumulation.

 

 

Section 2: Four Themes

 

Theme 1: China

China is on track for its slowest growth since the Mao era, although set against the gloomy global backdrop, economic performance has been exceptional. Structural weaknesses in China’s economy – demographics, rising debt burdens and diminishing returns on investment – are currently being papered over with stimulus.

Growth in China decelerated to an estimated 2% in 2020 – the slowest pace since 1976. It could have been worse but has been helped by effective control of the pandemic and public investment-led stimulus. Accommodative fiscal and monetary policies led to a sharp increase in the government deficit and total debt. Fiscal policy support, which initially focused on providing relief and boosting public investment, is starting to moderate. The recovery has been uneven as import growth lagged a rebound in exports, contributing to a widening current account surplus.

According to the World Bank Report, growth is forecast to pick up to 7.9% in 2021, above previous projections due to the release of pent-up demand, and to 5.2% in 2022 as deleveraging efforts resume. Even as GDP returns to its pre-pandemic level in 2021, it is still expected to be about 2% below its pre-pandemic projections by 2022.

We remain concerned about China’s rising debt and uneven recovery.

 

Theme 2: Interest Rates

The pandemic led to a global recession as governments shut down large segments of their economies in an effort to slow the spread of the virus. Unprecedented monetary policy accommodation has calmed financial markets, reduced borrowing costs, and supported credit extension. However, historically low global interest rates may conceal solvency problems that will surface in the next episode of financial stress or capital outflows.

At the onset of the pandemic, short-term interest rates fell as central banks reduced short-term policy rates. The Federal Reserve, for example, reduced the federal funds rate (that is, the interest rate that financial institutions charge each other for overnight loans of their monetary reserves) from 1.6% to near zero over a two-week span in early to mid-March.

Long-term interest rates fell as well, as central banks, including the Federal Reserve, made direct purchases of long-term securities and instituted a number of lending programs aimed at maintaining the functioning of financial markets. Additional downward pressure on long-term interest rates came from investors shifting out of risky assets, such as equities, and into safe assets, such as U.S. Treasury securities. Rates were also held down by the fall in demand for investment as firms postponed and cancelled capital expenditure projects.

The 10-year Treasury yield bottomed in August and is above 1% in the first week of January 2021, for the first time since March last year. This follows the Georgia Senate run-off election and an ensuing rise in the chance that the Biden administration passes further fiscal stimulus. The recent rise in rates has effectively been a tightening but the Fed is unlikely to let monetary conditions continue to tighten, as the economy continues to recover. Yields have edged up in the U.K., but not to the same extent as in the U.S. The recovery in risky assets has continued to push down corporate bond spreads, below their pre-virus levels. The next round of fiscal stimulus is expected to assist the state and local government sector. Munis are attractive as a result and have rallied as Treasuries sold off.

The rise in market rates and steepening yield curve is a big plus for financials, especially for the regional banks which will not face any regulatory risk. There is concern over commercial real estate exposure, but that is really a problem that commercial mortgage-backed securities and structured finance players will confront.

We continue to have concerns that asset prices have been driven up by exceptionally loose monetary policy and that they will reverse once central banks start to raise real interest rates back towards their historical levels. At the same time, the equilibrium level of real interest rates is lower than in the past and this is expected to cushion and correction.

 

Theme 3: Inflation

In general, the global inflation story has continued to be one of disinflation due to subdued demand outweighing boosts to price pressures from coronavirus-related supply constraints. Deflationary pressures from technology are likely to remain muted. Inflation rates are subdued, as they have been for the past decade, but stimulus and demographic trends could prompt a comeback. Higher public debt burden, slower global labor force growth, and the possibility that globalization will be partly reversed, will lead to a gradual rise in inflation over the longer-term. In the near term, with oil prices around $55 per barrel, base effects will ensure a jump in energy price inflation on the anniversary of last April’s collapse in oil prices.

In the U.S., the pandemic has increased the odds of future inflation, as the Fed is expected to be less committed to ensuring price stability in the future. There is no other central bank as openly committed to policy easing as much as the Fed, and no other central bank boosting the monetary aggregates at the same pace. The Fed has stated that it will not touch rates for three more years even if inflation crosses above 2% and the jobless rate drops below 4%. 3% inflation is something the central bank would be fine with. That would imply a prolonged period of negative real rates, which should be bullish for long-duration assets, bullish for hard assets, and bearish for the dollar.

 

Theme 4: Commodities

Energy and Gold Prices in 2021

Oil prices partially recovered over the second half of 2020 as production fell sharply. This rebound was more modest than the broader recovery in commodity prices as oil demand disappointed while the rise in other commodity prices was mainly driven by strong demand from China. We expect the demand for oil in 2021 to remain subdued and prices to stay within the current range.

Gold was one of the best performing major assets of 2020 driven by a combination of high risk and low interest rates. Given our more cautious outlook for the speed of the recovery, compared to a crypto currency like bitcoin, the risk that gold could go to zero does not exist as there is a floor in its price, because it has physical properties that make it useful even outside of its primary function as a safe-haven asset. Bitcoin, which has marginal intrinsic value, relies on the faith of its holders that it is worth more than nothing and that the technology is sound. We note that the volatility of bitcoin is five times that of gold.

We do not expect to see a strong rebound in energy prices from here but the environment that we have described may result in strong gold investment demand, which could offset low consumption as it did during 2020. We believe there are strong arguments for holding a portfolio that includes hard assets such as gold, things that will keep their value in the face of the ongoing risks that we have discussed in this Outlook.

 

 

Section 3. Investment Outlook

 

Global Pandemic Leads Us to a Recession Forecast for the Next Twelve Months

 

SOURCE: FRAME GLOBAL ASSET MANAGEMENT

 

Frame Global Asset Management considers these trends and factors them into our outlook for the economy in our twelve-month forward period. We look back to periods of similar economic behavior and use this information to predict the future behavior of the asset classes that we consider. Our investment process allows us to adapt for non-traditional monetary policy and other exogenous variables.

 

 

Section 4. December 2020 Portfolio Models

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. We have maintained our Recession outlook over our forecast horizon of the next 12 months.

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.

 

Deborah Frame, CFA, MBA

President and Chief Investment Officer

January 14, 2021

 

iJohns Hopkins University. National Public Health Agencies. January 18, 2021.
iiWorld Bank. 2021. Global Economic Prospects, January 2021. Washington, DC: World Bank. doi: 10.1596/978-1-4648-1612-3. License: Creative Commons Attribution CC BY 3.0 IGO.
iiiWorld Bank. 2021. Global Economic Prospects, January 2021.
ivWorld Bank. 2021. Global Economic Prospects, January 2021.
vWorld Bank. 2021. Global Economic Prospects, January 2021.
viWorld Bank. 2021. Global Economic Prospects, January 2021.
viiWorld Bank. 2021. Global Economic Prospects, January 2021.
viiiWorld Bank. 2021. Global Economic Prospects, January 2021.
ixWorld Bank. 2021. Global Economic Prospects, January 2021.

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

 

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

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

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

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

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

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.

 

 

Global growth momentum continued into October, as industrial activity and trade readings from the U.S., China, and Japan pointed upward. Good news regarding various vaccine trials increased confidence that the pandemic will be less of a drag by Q2 2021. In the near term however, downward revisions to growth reflect recent restrictions on activity across several U.S. states and across developed markets including Canada, the Euro area, Japan, and the U.K. We expect to see global GDP contract in Q4 2020 and Q1 2021, followed by a slow recovery. As we do not see a clear path through the chaos resulting from the COVID-19 pandemic, traditional business cycle analysis does not fit. Rather, this is in line with the shock of a natural disaster. We have maintained our Recession outlook over our forecast horizon of the next 12 months.

In China, virus management has largely been successful. The Chinese economy’s first-in, first-out status regarding the COVID-19 shock is clear in the swings in its industrial activity. After plunging 13.5% year over year in February, industrial production growth resumed when factories re-opened and workers returned with IP expanding by 6.9% year over year in October.1

The renewed lockdowns in Europe appear to be turning the tide on the surge in infections. Countries that have put aggressive restrictions in place, like France, Spain, and Belgium, have seen the greatest improvement. On November 5, the Bank of England announced it would inject £150 billion into the U.K. economy to help soften the impact of the new lockdown. Large fiscal supports there have pushed the deficit close to 11% of GDP this year.2

In the U.S., October’s durable goods data suggest the economy started the fourth quarter on a strong footing, but the second consecutive weekly rise in initial jobless claims is a warning sign that the latest spike in coronavirus cases has triggered a new bout of economic weakness. U.S. jobs fell 9.3% from their peak and have recovered less than half of this decline thus far.3 Close to 10 million U.S. workers are likely to lose their unemployment benefits at the start of next year, amounting to an income loss of roughly $170 billion annualized.4 Durable goods orders increased by 1.3% month over month in October.5 On a three-month annualized basis, core CPI inflation is running above 2%.6 Of the $750 billion of combined funds in the two major Fed purchasing programs, the Fed used only $13 billion by the end of September, encouraging corporate bond issuance, and creating high yield bond demand.7 We expect a fiscal response by way of a stimulus package in Q1 2021. Canada saw a surge in its COVID-19 cases following its October Thanksgiving, which sends a worrisome signal for the U.S. holidays. As provincial authorities have tightened restrictions, growth is expected to stall next quarter.

News of the high effectiveness of the Pfizer and Moderna vaccines helped push the S&P 500 to a record high and caused longer dated Treasury yields to rise closer to 1%, even as the Fed’s commitment to low interest rates kept short-term interest rates anchored near zero. The S&P 500 declined 2.7% in October, as concerns mounted over rising coronavirus infections, mixed earnings results, and the Presidential and Congressional elections. Smaller cap stocks outperformed, with the S&P Mid Cap 400 and the S&P SmallCap 600 rising 2.2% and 2.6%, respectively. The Canadian S&P/TSX Composite was down 3.1%. European equities slid sharply lower after a resurgence in cases of COVID-19 led to increased restrictions across the continent. The S&P Europe 350 dropped 5.0% on the month. The S&P United Kingdom declined to finish the month with a loss of 5.0%, as Brexit negotiations continued to drag on and the government attempted to fine-tune virus control measures by region. Emerging Markets gained 2.04% as measured by the S&P Emerging BMI. The risk-on mood in markets has further undermined the dollar, which on a trade-weighted basis, has hit an 18-month low.

In November, we maintained the asset allocation that was established in October for all models. While continuing to favor shorter duration fixed income, we shifted exposure from Mortgage-Backed Bonds that have been supported by the Fed asset buying program to Municipal Bonds that will benefit from expected fiscal spending on infrastructure. 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.

There are numerous catalysts for market volatility in the fourth quarter with the primary one being the premature withdrawal by governments seeking to repair some of the damage to public finances. 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

 

Trading Economics. China Industrial Production. November 16, 2020.

Trading Economics. U.K. Government Budget. November 2020.

Trading Economics. U.S. Employment. November 2020.

Trading Economics. U.S. Employment Forecast. November 2020.

Trading Economics. Durable Goods Orders. November 25, 2020.

Trading Economics. U.S. CPI. November 2020.

The Federal Reserve. FOMC notes. November 5, 2020.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. October 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

 

Trading Economics. China Exports. October 13, 2020.

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.

 

 

Section 1: Q4 2020 Outlook

 

Teetering Between Recovery and Chaos

COVID-19 has depressed economic activity around the world. Monetary and fiscal responses from governments and central banks in both developed and emerging economies since March are without precedent, far surpassing actions taken during the global financial crisis.

We are currently living in a world that is teetering between recovery and chaos. As a Portfolio Manager, our job is to offer you solutions that provide your investments with the best protection through our portfolio models, addressing the current uncertainty and acknowledging the new economic regime that is the outcome of this global event.

Containing the virus’ spread is the best way to save the economy and investment markets. Policies that allow economic activity to proceed safely, without placing people at undue health risk are needed. The global economy cannot recover until the epidemic is under control. This will happen when efforts to provide relief to individuals and businesses complement efforts to control the spread of the virus.

These are unprecedented times. Investors want to minimize volatility and losses. Traditional investment management that focus on broad diversification among asset classes and relative over and under weights to a broad array of asset classes have experienced losses. The Frame Global Asset Management investment process addresses the global movement of capital into and out of the U.S. and incorporates a forward-looking view of where capital is heading in this changing world.

We know that there is a direct link between macroeconomic and geopolitical uncertainty and volatility and correlations within markets and asset classes. We also know that capital around the world moves to markets where it sees the greatest opportunity. This is largely driven by relative interest rates, currency differentials, and perceived safety/risk. Common sources of macro risk – including the Fed, energy prices, geopolitics, inflation shocks, regulatory change, sovereign risk, elections, and fiscal-policy dysfunction – can affect both single stock volatility within an asset class and the correlation among stocks and bonds.

The chaos of the economic collapse during this pandemic has obscured the initial impact of global central bank actions. Emergency programs have come while nominal interest rates are low by historical standards. As a result, monetary policy will be constrained in its ability to provide further support to a recovery. Aside from rate cuts, central banks have also begun to increase the money supply via a sweeping Quantitative Easing program. But the conditions for QE to stimulate demand are less favorable now than they were in 2008–2014. This is because the current recession combines a shock to demand with a shock to supply. As supply chains are broken and workers cannot report to their jobs, many firms are not be able to increase output and would not be able to even if the demand returned.

 

The State of the Global Economy

In the face of large budget deficits, a stock market bubble, and the impact of plummeting oil prices from last year, the state of the global economy was less than ideal heading into 2020.

One of the rare benefits of crises and recessions is that they remove both unproductive firms and financial excess, creating space for more productive firms and fresh financial investment. This did not happen after the Recession of 2008, resulting in a weak economic recovery from the crisis that varied in economies around the world. In dealing with the Great Financial Crisis (GFC) of 2008, the U.S. recapitalized, merged, and permitted the failure of some banks, but Europe chose the opposite approach resulting in undercapitalized and ailing banks surviving.

However, the most impactful mistakes were made after the GFC on both sides of the Atlantic. For the past decade, central banks have enacted zero or negative interest rate policies and sought to manage economic downturns through policies of quantitative easing (QE). Such programs were adopted in Japan, the European Union, and United States, each with varying degrees of success. Intermediary banks paid the sellers of bonds (households, funds, banks, etc.) and the Fed compensated the banks with reserves. In practice, the Fed forced excess reserves onto the balance sheets of banks far beyond levels they would have acquired independently. Because of the higher supply of reserves system-wide, their marginal benefit decreased, bidding up the prices of various securities. This led the banks to issue additional and often riskier loans until the balance of the marginal benefits was restored. Also, because Quantitative Easing and low policy rates depressed long-term rates, many of the securities that the commercial banks held had no yield advantage over reserves, making the banks more likely to substitute less-liquid securities with more credit risk.

More than ten years later, through FX reserves and through QE programs, central banks globally hold government bonds issued by a relatively small number of advanced economies. Meanwhile, growth in the wake of the 2008 financial crisis slowed and the U.S. economy began to show signs of recession heading into 2020.

 

The Monetary Policy Challenge and the Unintended Consequences of Quantitative Easing

From its initial detection in Wuhan, China to the outbreak’s late-February global explosion, the early 2020 onset of the novel coronavirus (COVID-19) pandemic brought chaos to financial markets worldwide.

During the immediate aftermath of COVID-19 reaching pandemic proportions, led by the U.S Federal Reserve (FED), central banks around the globe fought massive uncertainty and took action to restore pricing stability. In an attempt to mitigate the negative economic implications of the coronavirus, a new policy of unlimited quantitative easing was implemented.

The experience of using QE through the past decade has made us aware of a number of unintended consequences. As quantitative easing lowers long-term interest rates, a low-cost financing environment can lead to excessive speculative behavior, which will lead to rapid expansion of debt and add to the market risks. In addition, quantitative easing can lead to excessive issue of cash and push up asset prices, creating bubbles. Globally, quantitative easing is likely to generate more debt and market risks in other countries, especially for emerging economies. If the United States attempts to withdraw easing policies in the future, emerging markets might experience currency devaluation and a fall in the stock market, given the current influx of large amounts of capital to emerging market countries. And although unlimited quantitative easing may lead to a quick economic recovery in the short term, it ignores the urgency of long-term and deep-seated structural problems in the U.S. and other economies.

 

A New Wave of Disinflation

One of the concerns raised about QE that has not proven to be threatening in this pandemic is inflation. To glean insights into the possible economic consequences of Covid-19, a Federal Reserve Bank of San Francisco working paper examined the medium- and long-term effects of 15 pandemics, ranging from the Black Death in the 14th century to the 2009 H1N1 outbreak.i

 

Response of the European Real Natural Rate of Interest Following Pandemics and Wars

SOURCE: ÒSCAR JORDÀ, SANJAY R. SINGH, ALAN M. TAYLOR. 2020. “LONGER-RUN ECONOMIC CONSEQUENCES OF PANDEMICS,” FEDERAL RESERVE BANK OF SAN FRANCISCO, WORKING PAPER 2020-09. VIA MARK YAMADA ON ADVISOR’S EDGE.

 

The figure above shows how the natural rate of interest responded after the pandemics ended (defined as a smoothed risk-free rate plus a high-quality bond return premium). The figure shows pandemics have been deflationary for decades following the event, while wars have been inflationary. Recessions are usually deflationary because low output and low demand temper prices.

 

Risk Appetite

The distinction between Pandemics and wars comes down to risk appetite. The reality is that we are in uncharted territory and the future is very much dependent upon how the public health crisis evolves. Until risk appetite recovers, disinflationary pressures will prevail. Inflation may come back into focus to the extent that supply is constrained, because of layoffs and the lag time required to re-hire and re-train. Demand could return because of income replacement from unemployment insurance and other government relief measures. These could be exacerbated by the type and timing of additional relief measures.

Fiscal policy has a necessary role in this recovery. In the U.S. it is the responsibility of Congress and the White House, not the Fed. At this point Congress needs to start deploying all its fiscal tools. The proposed $2 trillion package of loans to businesses and cash for households is not guaranteed to bring a swift, V-shaped recovery. The CARES Act is not stimulus, it is relief. Essentially, it is income and cash flow replacement. It is bridge financing, not outright stimulus. The federal government is attempting to create a bridge over a crisis that has caused incomes for individuals and businesses to disappear because of behavioral changes and rolling lockdowns to flatten the infection curve. Stimulus depends on how funds are administered. 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.

At the end of the day, this all comes down to risk appetite. Capital reserves are endogenous – a closed system. They cannot be and are not lent out. They always stay within the fed funds system. Secondly, banks create credit – not the Fed. Lastly, credit is a function of risk appetite. What does this all mean for inflation? QE and increasing excess reserves are not inflationary unless there is demand for credit, which is driven by risk appetite. Unless there is risk appetite to borrow and banks have risk appetite to lend, then reserves just sit there as excess reserves.

Until risk appetite recovers, disinflationary pressures likely prevail. With that said, we are in uncharted territory and the future is very much path dependent upon how the public health crisis evolves. As we have come to learn through this crisis, almost anything is possible, but inflation fears should be of little worry at the moment.

 

The Price of Saving the Economy

The federal budget deficit has soared to a record $3.1 trillion in the 2020 fiscal year, as the coronavirus pandemic fueled enormous government spending while tax receipts plunged as households and businesses struggled with economic shutdowns.ii

The Fed has increased the size of its footprint in the economy by more than two-thirds and proved to investors that it would step in to buy entirely new kinds of assets.

The gap between what the U.S. spends and what it earns through tax receipts and other revenue is now $2 trillion more than what the White House budget forecast in February. It is also three times as large as the $984 billion deficit in the 2019 fiscal year.iii

The shortfall underscores the long-term economic challenge facing the United States as it tries to emerge from the sharpest downturn since the Great Depression. Interest rates are low, meaning it costs less for the government to borrow money, although the ballooning deficit is complicating policy choices as Republicans resist another large stimulus package, citing concerns about the U.S. debt burden.

This massive deficit is the result of two Fed policies. First, when panic struck financial markets in March, Fed officials lowered the target for their benchmark rate to a range of zero to 0.25%, where they say it will likely remain for years. They have consistently ruled out pushing rates into negative territory. Second, large-scale bond repurchases, interbank loans, corporate loans and currency swaps were executed. In late 2019, nominal interest rates from the overnight to a 10-year maturity averaged between 1.5 and 2 percent. On March 3, 2020, the Federal Open Market Committee reduced the Federal Funds Target Rate by ½ point to 1.00%-1.25% in an emergency policy move. Two weeks later, on March 15th, the FED elected to drop the Federal Funds Target Rate to 0.0%-0.25% to calm the markets. The Fed currently purchases about $120 billion a month combined in Treasuries and mortgage-backed bonds. The damage of the COVID-19 recession will be magnified by the Federal Reserve’s inability to cut interest rates further, leading it to undertake massive additional asset purchases. As the Fed continues to push further into different corners of the economy, it is making it more difficult to get out at some point.iv

History shows that the Fed’s interventions in the name of crisis management are very difficult to withdraw from once a crisis is over. The actions it took from 2008 to 2010, presented as temporary, remain largely in place.

Michael Kiley, a senior Fed economist and deputy director of the bank’s financial stability division, has forecast that bond purchases equal to 30% of U.S. economic output (about $6.5 trillion) will be required to offset the impact of the Fed’s benchmark rate already being nearly zero. The Fed has so far purchased bonds through so-called open-market operations and emergency lending facilities equal to about $3 trillion since March, implying that another $3.5 trillion is needed, to make up for the monetary policy handicap of zero rates.

Globally, QE by central banks in 2021 is expected to more than double the previous peak in 2010 after the financial crisis. Quantitative easing in Central and Eastern Europe has aided coronavirus crisis responses but risks would be more pronounced if QE undermined perceptions of central bank independence and economic policy framework credibility according to Fitch Ratings.v

 

Since the Onset of this Stress Event, We Have Demonstrated that Our Investment Approach is Successful

Traditional investment managers are handicapped when their portfolios are “macroeconomic regime” agnostic. The Frame Global Asset Management investment process monitors the global movement of capital into and out of the United States. Markets are forward looking, and when we look at the behavior of markets, we see that they eventually reflect the reality of the current and anticipated future macroenvironment. We make extensive use of our internal expertise in interpreting economic data. We exploit these inefficiencies and provide our clients with superior outcomes. We focus on minimizing capital losses by recognizing macro and geopolitical risks that are present and expected over our forecast time horizon

In July, we maintained the asset allocation that was established in June for all models. We continued to be positioned in shorter duration fixed income. We expected interest rates to remain low or negative across the globe and as a result, we continued 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. We are continuing to monitor the recovery in Europe following the Eurozone’s agreement on a stimulus package. Within FX, we are monitoring the US dollar, which tends to perform inversely with global growth. Independent shocks to risk including politics and the outcome of the U.S. election in November could affect dollar performance over the back half of 2020.

In August, we maintained the asset allocation that was established in July for all models. We continued to be positioned in shorter duration fixed income. We expected interest rates to remain low or negative across the globe and as a result, we maintained exposure to gold while monitoring four variables: the US dollar, stock market volatility, real interest rates, and inflation. We continued monitoring the recovery in Europe following the Eurozone’s agreement on a stimulus package.

In September, we maintained the asset allocation that was established in August for all models. We continued 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 have maintained exposure to gold. The U.S., as the largest democracy in the world, is still seen as the safest place to invest. The Bank’s monetary policy objective is to deliver price stability and, subject to that, to support the Government’s economic objectives including those for growth and employment. Monetary stability means stable prices and confidence in the currency. A reflection of this stability has been evidenced through most of history as capital flows to the U.S. from abroad for opportunity and to escape other relatively riskier international environments.

 

Economic Regime Based Investing

Unfortunately, a multitude of variables persist regarding the containment and eradication of the COVID-19 contagion. Until the U.S. addresses the long-term structural problems of its economy, ranging from an aging population, to inadequate welfare policies, worsening income inequality, low productivity, insufficient investment in the real economy, and long-term fiscal and foreign trade deficits, it is entirely plausible that the Fed will be struggling a decade from now to undo the emergency actions of today. It is very likely that a new economic regime is underway. Our investment approach allows us to anticipate and adapt to a change like this.

 

 

Section 2. Four Themes

 

Theme 1: The November U.S. Election

While the course of the pandemic is by far the biggest risk to our forecasts over the next year or two, the November 3rd elections have the potential to leave a wide-ranging and long-lasting impact on the economic outlook. The chaotic handling of the pandemic together with Trump’s response to widespread protests in American cities have helped Biden open a wide early lead in the national polls. A Joe Biden victory in November together with Democrats winning back control of the Senate could see a big increase in taxation and federal spending, together with a shakeup of healthcare, regulatory, and trade policy. Uncertainty is exacerbated by the impact of voting during a global pandemic on turnout models and potential operational issues including an increase in voting by mail.

Of more importance is the makeup of Congress, with a clean sweep of the House, Senate, and the Presidency enabling either party to loosen fiscal policy more markedly.

 

Trump & Biden’s Positions on the Key Issues

SOURCE: CAPITAL ECONOMICS

 

Theme 2: Secular Stagnation

The Pandemic is exacerbating secular stagnation that was already present before 2020. This refers to a rise in the amount of desired saving relative to desired investment, which has prompted interest rates to fall to balance the two. This in turn reflects various factors such as the impact on saving of ageing populations, shareholders’ desire for short-term returns, and a dearth of investment opportunities.

We anticipate rest-of-world GDP will finish this year nearly 5% below pre crisis levels as virus containment and macroeconomic policy are not being managed effectively. Recent policy developments have reinforced concerns on this front. Although treatment has improved and mortality rates have decreased, COVID-19 has not been contained and new cases globally have moved back to their mid-year high. At the same time, there is no evidence that fiscal policy is moving to offset the run-off in emergency stimulus.

 

Theme 3: A Flare-Up in Trade Tensions with China

The results of the phase one trade deal between China and the United States and the trade war that preceded it have significantly hurt the American economy without solving the underlying economic concerns that the trade war was meant to resolve. Six months after the deal was inked, the costs and benefits of this agreement are coming into clearer focus. The effects of the trade war go beyond economics. President Trump’s prioritization on the trade deal and de-prioritization of all other dimensions of the relationship produced a more permissive environment for China to advance its interests abroad and oppress its own people at home, secure in the knowledge that American responses would be muted by a president who was reluctant to risk losing the deal.

 

Theme 4: Forecast Uncertainty

The International Monetary Fund has noted several risks around their 2020 forecast.

The forecast sights the depth of the contraction in the second quarter of 2020 as well as the magnitude and persistence of the adverse shock. These elements, in turn, depend on several uncertain factors including:

• The length of the pandemic and required lockdowns
• Voluntary social distancing, which will affect spending
• Displaced workers’ ability to secure employment, possibly in different sectors
• Scarring from firm closures and unemployed workers exiting the workforce, which may make it more difficult for activity to bounce back once the pandemic fades
• The impact of changes to strengthen workplace safety—such as staggered work shifts, enhanced hygiene and cleaning between shifts, new workplace practices relating to proximity of personnel on production lines—which incur business costs
• Global supply chain reconfigurations that affect productivity as companies try to enhance their resilience to supply disruptions
•The extent of cross-border spillovers from weaker external demand as well as funding shortfalls
• Eventual resolution of the current disconnects between asset valuations and prospects for economic activity

 

 

Section 3. Investment Outlook

 

Global Pandemic Leads Us to a Recession Forecast for the Next Twelve Months

 

SOURCE: FRAME GLOBAL ASSET MANAGEMENT

 

Frame Global Asset Management considers these trends and factors them into our outlook for the economy in our twelve-month forward period. We look back to periods of similar economic behavior and use this information to predict the future behavior of the asset classes that we consider. Our investment process allows us to adapt for non-traditional monetary policy and other exogenous variables.

 

 

Section 4. September 2020 Portfolio Models

The global pandemic-induced GDP collapse has led to higher debt service burdens and lower ability to repay, resulting in an increase in non-performing loans and credit risk. We are now in a twilight zone of partial lockdowns. Fearful of rebellion, and of snuffing out signs of economic recovery, governments are opting for a hodge-podge of curbs. Financial intermediaries have become more risk averse, slowing the flow of much-needed new credit and debt. These signs of cooling are consistent with our view to maintaining our Recession Outlook for our forecast horizon of the next twelve months. Our outlook depends on what happens with fiscal policy and the spread of COVID-19, and we will continue to closely monitor these.

In September, we maintained the asset allocation that was established in August for all models. 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 have maintained exposure to gold. 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 are continuing to monitor the recovery in Europe following the Eurozone’s agreement on a stimulus package.

 

Deborah Frame, CFA, MBA

President and Chief Investment Officer

October 14, 2020

 

iFederal Reserve Bank of San Francisco. Longer-Run Economic Consequences of Pandemics. June 2020.
iiTrading Economics. U.S. Government Budget. October 16, 2020.
iiiTrading Economics. U.S. Government Budget. October 16, 2020.
ivFederal Reserve. FOMC Statement. September 16, 2020.
vFitch Ratings London. June 3, 2020.

 

The global pandemic-induced GDP collapse has led to higher debt service burdens and lower ability to repay, resulting in an increase in non-performing loans and credit risk. We are now in a twilight zone of partial lockdowns. Fearful of rebellion, and of snuffing out signs of economic recovery, governments are opting for a hodge-podge of curbs. Financial intermediaries have become more risk averse, slowing the flow of much needed new credit and debt. These signs of cooling are consistent with our view to maintaining our Recession outlook for our forecast horizon of the next twelve months. Our outlook depends on what happens with fiscal policy and the spread of COVID-19 and we will continue to closely monitor these.

In August, China recorded a trade surplus of US$58.93 billion, down from US$62.33 billion the previous month.1 Exports rose 9.5% from the year before while imports fell 2.1%.1 In Europe, the ECB updated its GDP forecast to contract 8.0% in 2020 and grow 5.0% in 2021 and 3.2% in 2022.2 UK GDP rose at an average monthly pace of nearly 6% in the three months through July, re-tracing slightly more than half of the decline recorded in March and April.3

In the U.S., only 48% of the 22 million workers let go during the shutdowns have regained employment, with unemployment at 8.4%.4 In September, the Fed mapped out a longer road with low rates. The most important outcome of this review was a shift in the Fed’s monetary policy strategy from flexible inflation targeting to average inflation targeting. This indicates the Fed will make up for periods of below-target inflation with periods of above 2% inflation. Lower rates mean lower income as inflation is positively correlated to yields. Uncertainty remains about whether another stimulus package will be passed. The next federal government will need to start filling a deep budget hole. Fitch’s downgrade of the country’s credit outlook to negative (while affirming its AAA rating) is a warning that lawmakers will eventually need to craft a credible path to fiscal sustainability.

In Canada, monthly real GDP was down 6% from pre-COVID levels in July. Household debt-to-disposable income plunged by a record 17.2% to 158.2% in Q2.5 Unemployment rates remain high at 10.2% with only 63% of the 3 million workers let go during the shutdowns having regained employment.6 This is happening even as wage losses have been more than offset by government income supports. The funds needed to finance CERB and other support programs resulted in a record increase in government debt ratios surging in Q2 and the deficit ballooning to $343 billion this year (16% of GDP) after holding fairly stable over the past decade. Gross general government debt (includes all levels of government) pushed up to 132.5% of GDP, the highest since 1996.7

In August and early September, the strength of the recovery and policy support underpinned the rally in equities as the U.S. stock market retraced earlier losses and reached a new record high. In August, U.S. equities posted their best monthly performance since April. The S&P 500 gained 7.2%, while the S&P MidCap 400 and the S&P SmallCap 600 gained 3.5% and 4.0%. Canadian equities were positive in August, with the S&P/TSX Composite up 2.4%. The S&P Europe 350 ended the month with a gain of 3.0%. Germany and France contributed the most towards the total. The S&P United Kingdom finished up 1.5%. Asian equities rallied in August, with the S&P Pan Asia BMI up 5.6%. All Asian single-country indices posted gains with the exception of Taiwan. The decline in the trade weighted US dollar since March was supported by a number of structural, cyclical, and political factors. Quantitative easing is not as positive for currencies as for other assets that are bought directly by developed-market central banks. To date, all asset purchase programs have been domestic only, eliminating the need for purchases of foreign currencies.

In September, we maintained the asset allocation that was established in August for all models. 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 have maintained exposure to gold. 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 are continuing to monitor the recovery in Europe following the Eurozone’s agreement on a stimulus package.

The historic first half of 2020 collapse in activity will require sustained robust global growth to achieve a full recovery. The ongoing pandemic, depressed employment, profits, and inflation and fading policy supports continue to slow the recovery. Social distancing, civil unrest, businesses struggling to stay open, schools struggling to reopen, national elections, and the Federal Reserve rewriting the rules of monetary policy create an environment where little is as it was. We will continue to monitor developments. 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

 

Trading Economics. China Balance of Trade. September 7, 2020.

European Central Bank Staff Macroeconomic Projections. September 10, 2020.

U.K. Office for National Statistics. July GDP Growth. September 11, 2020.

Trading Economics. U.S. Unemployment. September 4, 2020.

Trading Economics. Canadian Household Debt to Disposable Income. September 11, 2020.

Trading Economics. Canada Unemployment Rate. September 4, 2020.

Trading Economics. Canada Gross External Debt. September 10, 2020.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. August 31, 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.