Could Tech Gyrations End the Rally?

I have a great respect for incremental improvement, and I’ve done that sort of thing in my life, but I’ve always been attracted to the more revolutionary changes. I don’t know why. Because they’re harder.

Steve Jobs

Early September saw U.S. tech giants fall sharply, pulling down the entire S&P 500 as the six – Facebook, Amazon, Apple, Netflix, Google (Alphabet), and Microsoft (FAANGM) – companies account for nearly 30% of the index while the bottom 300 account for just over 13%. While the ebb and flow of the high-flying tech stocks is to be expected, some underlying trends are profoundly anchoring the longer-term outlook. Besides the earnings resilience during the pandemic, the return on equity (ROE) for Nasdaq stocks is above 20% (Chart 1). Meanwhile, Canadian and Europe, Australasia and Far East (EAFE) stocks struggle at about 5%, still much lower than the 11.5% ROE for S&P 500 companies and below the 9% of Emerging Markets (EM).  For investors that seek quality companies, the U.S. market remains a leader in an increasingly digital world.

Chart 1: Return on Equity Persistently Higher for Nasdaq

Chart 1: Return on Equity Persistently Higher for Nasdaq

Source: Blomberg, BMO GAM (As of September 15, 2020)

COVID-19 has Turbo-Boost E-Commerce

In parallel to the strong ROE of capital-light, tech-heavy companies, traditional brick and mortar shops are on a steady downward trend of their market share as we increasingly consume through E-commerce platforms (Chart 2). COVID has accelerated that trend and investors should be careful when assessing the outlook of sectors of the economy and their likelihood to play catch-up. We expect the global economy to rebound into 2021-22, but the economy is undergoing significant changes under the hood

Chart 2: No Sign of Bottoming for Department Stores

Chart 2: No Sign of Bottoming for Department Stores

Source: Haver, BMO GAM (Data as of July, 2020)

Market Pricing Reflecting Anxiety Regarding U.S. Election

The U.S. Presidential elections are fast approaching but we think investors should use the scope for greater market volatility to deploy capital. According to the term-structure of the CBOE Volatility Index (VIX), (Chart 3), investors are bracing for market turbulences around the election and sending the price for downside protection higher. Such pricing suggests that the scope for a significant risk-off is lower than it would otherwise be if the VIX was at a lower level. Meanwhile, we think the market pricing into 2021 fairly reflects more benign market conditions.

Chart 3: Term-Structure of VIX Fear Index Shows Investors Braced Ahead of U.S. Election

Chart 3: Term-Structure of VIX Fear Index Shows Investors Braced Ahead of U.S. Election

Source: Bloomberg, BMO GAM (As of September 16, 2020)

Portfolio Update: Launching of the BMO Sustainable Portfolios

We launched our BMO Sustainable Portfolios that invest in companies committed to positive environmental, social and governance (ESG) outcomes. The suite is proposed in 4 risk profiles: Income, Conservative, Balanced, and Growth. Our 5 Lenses framework is also applied in a similar fashion as what we do within our flagship BMO ETF Portfolios, but with an ESG set of building blocks, which includes actively managed equity and fixed-income mutual funds.

We like ESG because strategic interest has room to build, supported by fiscal policies globally. Governments are increasingly promoting sustainable investment projects, led by the European Union (EU). A third of the region’s COVID-19 rescue package is devoted to decarbonization and green technologies, or 10 times what other large economies spend. The EU’s next budget also includes stimulus to support the Green Deal, a plan to reach net zero emissions by 2050. The Deal itself will entail trillions of new green investments over the coming decades.

In the U.S., a Biden victory and/or Democratic sweep, which are currently favored in polls and betting markets, would allow for U.S. reengagement in global climate initiatives and a push toward stricter U.S. climate policy rules through both presidential and legislative actions. A Trump reelection would undoubtedly mean continued disengagement and potentially further deregulation, but at the same time other forces such as the private sector itself have proven to be important drivers as well. Indeed, ESG fund assets have nearly doubled in the past three years with significant inflows year-to-date, while ESG bond issuance is on track to reach $300bn in 2020. Shareholder activism, institutional interest, and preferences among Gen-Z and millennial generations are prominent trends driving ESG growth. Moreover, as a growing number of investors use ESG considerations, disclosure by firms has increased with 90% of S&P 500 companies publishing an ESG-focused report vs. 20% a few years ago. 

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