“We will not run out of money.”
– Jerome Powell. Federal Reserve Chairman, April 29, 2020
The Coronavirus Crash and Rally
It’s been a strange and historic start to 2020. What started as an outbreak of a new coronavirus strain in China quickly turned into a global pandemic, forcing countries to shut down businesses, restrict travel and implement social distancing measures. These actions crippled companies around the world. Stock markets dropped drastically as the virus struck down the longest-running bull market in US history, and unemployment reached 13.0 and 14.7 per cent in Canada and the US respectively, the highest levels seen since the Great Depression itself. While many of us knew it was only a matter of time until the next recession, few could have predicted the ferocity of our current decline.
And yet, stocks have been quick to recover from the steep drop in March, with the S&P 500 having its strongest 50-day rally ever in June (albeit markets remain down year-to-date). Fuelling the recovery was swift action from governments and central banks who quickly moved to stabilize the economy. In Canada, wage subsidies, business loans and unemployment relief in the form of the Canada Emergency Response Benefit (CERB) were introduced to keep Canadians spending, while in the US a monumental $2.8 trillion was spent to send Americans cheques in the mail and to keep struggling businesses afloat.
This has largely resulted in a divergence between the market and the economy. Amid better-than-expected unemployment figures, low interest rates, and the reopening of businesses around the world, many investors are now optimistic that things are returning to normal. Unfortunately, we are far from out of the woods. The virus remains a material threat, and early rollbacks of social distancing measures may have stunted progress against the virus; the US is now reporting more new daily cases of the virus than it was in April. With a vaccine unlikely to be widely available until mid-to-late 2021, it will be some time yet before things return to normal, and with few stimulus levers left to pull, it is unclear where the economy will go from here.
It is a scary time, but it is for these exact circumstances that we focus on higher-quality positions better-equipped to weather such hurricanes. As we wait for the storm to pass, it is important that we avoid succumbing to the fear and greed of the market which, as you can see from the charts, are fickle emotions. Nonetheless, do not hesitate to contact us if you have questions or concerns.
As always, we thank you for your support and continued confidence in WDS.
While the first couple months of 2020 saw the S&P/TSX Composite Index ($TSX) reaching an all time high of 17,944 on February 20th, stocks dropped drastically as COVID-19 reached North America, with daily declines reaching the double digits. The market bottomed out on March 23 at 11,228, a 37.4 per cent decline from its peak, however monetary and fiscal stimulus quickly restored investor confidence, resulting in a rally. As we ended the second quarter, the TSX found itself down just 9.1 per cent year-to-date (-7.5 per cent with dividends).
There was a wide discrepancy between how sectors performed. Information Technology ended the first half of 2020 up 62.0 per cent (total return) while Energy and Health Care both fell around 30.0 per cent, reflecting the strain COVID-19 has imposed on economic activity and medical resources.
The S&P 500 Index ($SPX) saw a similar trend, but ended the first half of 2020 in much better shape than its Canadian counterpart, down only 3.1 per cent on a total return basis year-to-date. This seems to reflect the index’s higher exposure to tech giants like Microsoft and Amazon who benefited from social distancing measures. In Canadian dollar terms, the S&P actually rose 1.8 per cent as the loonie depreciated.
International stocks were the worst off out of the three, with the MSCI EAFE Index ($MSEAFE) down 11.1 per cent. Countries like Germany and the U.K. were struggling with slow economic growth before the pandemic, and with politicians refusing to put off Brexit negotiations we may see further turbulence come 2021 when the transition period ends. Meanwhile, ongoing tensions between the US and China threaten to re-ignite trade hostilities.
Fixed Income and Interest Rates
After holding steady throughout 2019, the Bank of Canada quickly brought the policy rate close to zero with three consecutive cuts, dropping the target rate to 0.25 per cent in March. To support this target rate, the bank also started buying Government of Canada bonds. These actions should help support financial markets, making loans cheaper and more accessible for companies and households, however with debt levels already high and little room for further cuts, many remain cautious. Fitch Rating recently downgraded Canada’s credit rating from AAA to AA+ to reflect the higher stimulus-related borrowing from the government, while the Canada Mortgage and Housing Corporation increased its own lending standards, with the institution forecasting a nine to 18 per cent decline in home prices over the next year as layoffs reduce demand for real estate.
Despite the credit concerns, the FTSE TMX Canada Universe Bond Composite Index rose 7.5 per cent, suggesting that investors are still flocking to fixed income to lock in rates and side-step equity volatility.
Similar tactics were employed by central banks and governments outside Canada as well. The Federal Reserve in the US cut its own Federal Funds Target Rate Range from 1.50 – 1.75 per cent to 0.00 – 0.25 per cent, while the government introduced a multi-trillion-dollar stimulus package to send cheques to Americans and support businesses through the downturn. Furthermore, the Federal Reserve has expanded its quantitative easing and has even contemplated buying stocks to support markets. The scale of these fiscal and monetary measures is unprecedented, but then again, so is this pandemic.
Despite the Canadian and US central banks both cutting policy rates, the loonie exchange rate ($CDW) nose dived amid the downturn. The Canadian dollar fell below $0.70 USD in March before recovering in April and ending the first half of 2020 at $0.74 USD, a 4.3 per cent decline from the beginning of the year. The depreciation of the dollar comes down to the nature of Canada’s economy, which derives a larger share of its production from cyclical and interest-sensitive industries like real estate, finance, manufacturing and resources.
Canada also relies heavily on trade as a source of GDP, and while things have recovered since April, exports remain down 34.1 per cent as of May. Motor vehicles/parts and energy products remain particularly depressed, down 77.0 and 59.6 per cent respectively from May of 2019. Not all is bleak however – a cheaper dollar should help exports, and with the US-Mexico-Canada (USMCA) trade pact having come into effect July 1st, we may see more demand from our North American partners. Time will tell whether or not we run into any wrinkles under the new agreement.
Oil just can’t seem to catch a break. As the global economic engine stalled, the price of crude, which was slowly working its way back to the $70 USD range, began a historic plummet, with the West Texas Intermediate ($WTIC) falling below $12.00 a barrel in April. On April 20th we even saw oil futures drop into the negative range as traders holding maturing contracts found themselves struggling to offload their positions. Things have since normalized, however WTI is still down 35.7 per cent year-to-date, with barrels currently selling for $39.27.
Gold ($GOLD) on the other hand had a fantastic year. While the precious metal initially dropped with other asset classes in March, it ended the first half of 2020 at $1,783.66 USD, up 17.3 per cent. While still off from the ~$1,900 record set in 2011, it’s the highest the metal has been in 8 years, reflecting investor uncertainty. Inflation concerns may also be supporting the metal’s growth; while slower business activity has muted any growth in price levels, money supply has grown rapidly as a result of central bank stimulus measures. This could lead to higher price inflation once the economy exits the current recession.
This report is provided for your information. Conclusions and opinions given do not guarantee future events or performance. Facts and data provided are from sources we believe to be reliable, but we cannot guarantee they are complete or accurate. This report is not to be construed as an offer to sell or a solicitation of an offer to buy any securities. Before making an investment or adopting an investment strategy, each investor should review his investment objectives with their investment advisor. Watson Di Primio Steel (WDS) Investment Management Ltd. and individuals and companies who are related may, at any time, buy or sell securities that are hereby described in this report.