January Monthly MAST Commentary: Au Revoir, 2020, Time for a Shot in the Arm

  • The COVID-19 winter is dark and cold, but the vaccine rollout is under way while the fiscal taps are wide open. Recent economic and political developments comfort our upgrading of equities vs. bonds in December.
  • Because of the unusual nature of the COVID-19-induced cycle, we continue to believe the lowest hanging fruit for investors is to focus on overweighting global equities to benefit from the ongoing reflation trade rather than picking sectors.
  • Within equity factors, we think small-cap stocks are best positioned to benefit from fiscal stimulus, notably in the U.S. Without an old-fashioned inflationary, capex boom, Value stocks could linger in their value trap, in our view.
  • Regionally, we steadily prefer U.S. and Emerging Markets (EM) equities over Canadian and Europe, Australasia, and the Middle East (EAFE) markets to benefit from a U.S.- and China-led reflation play, while overweighting Investment Grade (IG) corporate bonds versus low-yielding government.

The best is yet to come.

Frank Sinatra

As we turned the page on 2020, COVID-19 vaccines began to be rolled out while fiscal taps are flooding the economy with cash, notably in Canada and the U.S. While the pandemic has worsened, we’re likely to see nearly half the population vaccinated by the summer. This backdrop anchors our bullish 6- to 12-month view for equities. Noise around virus mutation is likely to increase in coming months, but this is to be expected and it’s unlikely to render the vaccines ineffective, although there remain some question marks. Meanwhile, fiscal hawks are nowhere to be found and politicians seem lured by the mirage of free money for the foreseeable future. Upcoming macro indicators are expected to show a loss of growth momentum, but investor confidence is unlikely to be shaken as the focus remains on vaccine rollout with strong growth momentum into the second half of 2021 and into 2022.

Global Markets: Strong finish to a wild year

Global equities (MSCI ACWI, +4.7%) ended 2020 on a strong note, led by emerging markets and U.S. shares. In December, emerging equities (MSCI EM, +7.4%) added to their solid 2020 performance (+18.3%) as China and South East Asians economies quickly emerged from COVID-19 lockdowns last spring and were able to ramp up their exports to western economies which were on a consumption binge. In the U.S., small-cap stocks (Russell 2000, +8.7%) have led the rally in the second half of 2020 and registered their best quarterly performance (+31.4%) as aggressive fiscal stimulus is expected to support broad economic activity and particularly benefit smaller firms. After suffering a steep earnings contraction during the pandemic storm, smaller businesses have benefited from the broad rebound in household demand and fiscal stimulus.

The tech-heavy Nasdaq 100 capped a shining year (+48.9%) and gained in December (+5.1%) as the capacity to grow digital revenues while COVID-19 cases are surging remains attractive. For the S&P 500 (+3.8%), the addition of Tesla is tilting the index even more into the New-Economy, growth territory. European shares (Euro Stoxx 50, +1.8%) lagged after their stellar November gains of 18% but nevertheless ended the year in negative territory (-3.2%) as the economic damages from COVID-19 added to an already weaker region. Finally, Canada’s S&P TSX lagged in December (+1.7%) to cap a modest gain for the year (+5.6%). Interestingly, Canada’s tech champion, Shopify, single-handedly contributed for roughly 4 percentage point of that gain.

2020 Regional Equity Performance

  • UK FTSE 100: -11.55%
  • France CAC 40: -4.96%
  • Italy MIB: -3.30%
  • Eurostoxx: -3.20%
  • Hang Seng: -0.46%
  • German DAX: 3.55%
  • Swiss Market: 4.35%
  • MSCI EUROPE: 5.38%
  • Canada S&P TSX: 5.60%
  • MSCI World: 16.82%
  • Japan Nikkei 225: 18.26%
  • MSCI EM: 18.30%
  • Russell 2000: 19.96%
  • Nasdaq 100: 48.88%

Source: Bloomberg, BMO GAM (as of Dec 31st, 2020)

Long-term interest rates remain well anchored and the yield on Canada’s 10-yr bonds was steady, ending the month at 0.68% (from 0.67%) as the world ended 2020 with a staggering $18tn of negatively yielding debt, up from $11.3tn in 2019. Oil prices rose to $48.52 (from $45.34) on vaccine optimism but nevertheless ended 2020, 20% lower. The greenback (U.S. dollar Index, -2.5%) fell in December as the global-reflation theme continues to lift most currencies against the dollar. The loonie benefited from that tailwind and ended the year at a surprising $0.78. Despite decent gains for U.S. equities, the VIX volatility index rose slightly to 22.8% (from 20.6%) as investors remain somewhat anxious regarding further equity downside as the pandemic is in full motion, although the VIX is well below the pandemic heights when it touched 82.7%.

Equity Factors: Pandemic fractures within global equity factors in 2020

The Growth outperformance of Value stocks continued in December as global Growth (+5.1%) equities led Value (+4.2%) stocks to end 2020 with a sizeable gap of about 29 percentage points in 2020, the largest yearly performance gap going back to data inception in 2000. Momentum (+5.1%) was the only other global equity factor outperforming global stocks (MSCI ACWI, +4.7%) last month. Low-Volatility (+2.1%) equities, the weakest factor in 2020 (+0.6%), continued to lag as investors prefer higher-beta stocks to play reflation.

The Blue Wave revival has re-ignited hope for Value-Growth rotation, but we continue to think that within the equity-factor space, Small-Caps are best positioned to benefit from both the vaccine rollout and fiscal stimulus. Comparing the 2020 performance between Small-Cap (+19.9%) and Value stocks (+2.7%) already shows a wide divergence, suggesting these two factors are not the same trade as some have believed following the positive vaccine developments. Given that both are exposed to similar macro drivers (higher rates and economic growth), this could imply that Value stocks could be plagued by value traps more than previously envisioned, unless an old-fashioned inflationary, capex boom was unleashed.

Canadian Low-Vol (BMO Canadian Low-Volatility Equity ETF, ticker: ZLB, -0.9%)* stocks’ performance mirrored their global peers and lagged the broad BMO S&P TSX Capped Composite Index (ticker: ZCN, +5.5)** in December. A major market surprise to us in 2020 was to see Low-Vol stocks suffer as much as broad indices during the COVID-19 storm as several Low-Vol constituents were highly exposed to the lockdowns across different industry groups, such as Retail, Banks or REITS.

2020 Reflections: A rare vintage

The U.S. dollar index (DXY) closed out 2020 down 7%, reflecting strong appreciation in G10 currencies led by the Australian dollar and the Euro. But the path was far from smooth. In March, the U.S. dollar rose to a 3-year high and proved to be the only true safe haven asset (i.e., actually rising in value) during the COVID-19-induced selloff. While we still expect U.S. dollar depreciation to continue in 2021, we must keep in mind its safe-haven properties should the road to recovery be bumpier than expected. All told, vaccine uptake, economic reopening, unprecedented levels of global stimulus coupled with a more friendly U.S. trade regime suggest further U.S. dollar weakness. The latest results in the Georgia Senate race pointing to a Democratic sweep further underpin this view. Remarkably, the loonie has been the weakest performer across the G10, rising just 2.1% in 2021. This could reflect the structural growth challenges tied to household indebtedness and the energy sector that lie ahead, in our view.

2020, an Epic Roller-Coaster Year for Asset Performance

  • WTI: -54.65% in March 2020; -33.15% for calendar year 2020
  • U.S. Dollar: 0.9% in March 2020;  -6.7% for calendar year 2020
  • U.S. Fixed Income: -0.6% in March 2020; 7.5% for calendar year 2020
  • S&P 500: -12.4% in March 2020; 16.3% for calendar year 2020
  • Gold: -0.5% in March 2020; 25.1% for calendar year 2020
  • Nasdaq: -10.1% in March 2020; 43.6% for calendar year 2020
  • Bitcoin: -25.3% in March 2020; 305.1% for calendar year 2020

Source: Bloomberg, BMO GAM (as of Dec 31st, 2020)

Central banks learned from their past mistakes in previous crises and committed to swift and extraordinary action as economies began to shutter in Q1, prompting us to overweight interest rate duration. Emergency facilities and backstops effectively restored liquidity, allowing fixed income to fulfill their purpose as shock absorbers in balanced portfolios and firms to borrow as needed. Central banks also slashed interest rates and ramped up quantitative easing (QE) purchases, pushing down borrowing costs for firms and households. The U.S. 10-yr bond yield traded at 0.91% at the end of 2020, or 10 basis points lower than a year prior, marking the best year for U.S. Treasuries since 2011. What’s more, the Fed has also shifted to a lower for even longer policy guidance by requiring inflation to overshoot 2% before raising rates.

The market implications of lower rates are significant. Monetary stimulus has cushioned firms and households through lower borrowing costs and led to higher valuations for real assets as housing, precious metals and equities. Moreover, cheap money is a key reason why valuations of long-duration equities, e.g., growth stocks, are likely to remain well supported in 2021. The fall in real rates (interest rates minus inflation), helped also by greater fiscal stimulus, largely drove gold’s 25% gain in 2020.

The Fed’s and the Bank of Canada’s corporate bond facilities, despite limited uptake, were especially effective as their mere existence helped remove stress in fixed-income markets and later allowed debt issuance to soar as 2020 saw the largest gross issuance of IG corporates. The quick restoration of liquidity as well as central bank commitments to buy corporate credit led us to take advantages of market dislocations and overweight corporate IG credit. U.S. IG returned 9.9% in 2020, while HY was not far behind at 7.1%. Though corporate spreads look fully priced, we think the reach for yield will be supported by the vaccine-led recovery and the resolve of central banks to achieve their inflation and employment mandate.

Outlook and Positioning: Positioned for upside, not for tearing up

We upgraded our equity versus bond overweight last December and recent developments comfort our upgrading of equities vs bonds. We still prefer U.S. and EM equity markets versus Canadian and EAFE shares as the drivers of the U.S. and EM outperformance remain intact and are leading the economic recovery. Our pro-risk stance also has an overweight to IG corporate bonds to Federals, while we are hedging against downside surprises with a small duration overweight. Further fiscal stimulus should keep some upward pressure on interest rates, but we think equities will benefit more as central banks cannot let long-term rates rise too much, although the Fed might let rates test equity resilience a bit before sounding concerned by financial conditions.

Disclosures

* The performance for (ZLB) for the period ended December 31st, 2020 is (as follows: 1.64% (1 Year); 6.36% (3 year); 8.60% (5 year); and 12.05% since inception (on October 21st, 2011).

**The performance for (ZCN) for the period ended December 31st, 2020 is (as follows: 5.75% (1 Year); 5.76% (3 year); 9.32% (5 year); 5.56% (10 year); and 6.95% since inception (on May 29th, 2009).

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