December Monthly MAST Commentary: COVID-19 Surge Not Hampering Equity Rally ahead of Cold Winter

Vaccine developments have opened the door to market rotation toward cyclicals and value.
December 2020


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  • We upgraded our equity outlook as key elements of uncertainty have moved to the rearview mirror while the vaccine is no longer just a hope. The winter will likely be dark and cold, but with the vaccine rollout under way, fiscal and monetary stimulus will help bridge the way to a more normal life in 2021.
  • Vaccine developments have opened the door to market rotation toward cyclicals and value. Energy and financials have outperformed, and while these are attractive tactical plays, they will continue to face long-term headwinds after the COVID-19 storm passes. 2021 Earnings per share (EPS) growth projections for cyclicals have not revised meaningfully higher, whereas expectations for COVID-19 winners info tech, healthcare and communications remain at the top of the pack.
  • We think investors should remained focused on overweighting global equities to benefit from the reflation trade, rather than seek to pick outperforming sectors or factors as the longer-term theme of tech earnings leadership is not expected to go away.
  • Regionally, we continue to prefer U.S. and Emerging Markets (EM) equities over Canadian and Europe, Australasia, and the Middle East (EAFE) markets as we continue to expect earnings outperformance, while Investment Grade (IG) corporate bonds look more attractive than riskier High Yield (HY).
News of COVID-19 and scope for a split U.S. government helped drive equities to realize double-digit gains in November even as COVID-19 cases were surging across Europe and North America. With the vaccine rollout starting, the scope for achieving 50% vaccination rates is looking promising, which would thereby allow for a more normal life to resume early in the second half of 2021. While COVID-19 cases are expected to rise into year-end and remain elevated during the winter months, we expect financial pressures against some highly impacted sectors of the economy to persist. However, we don’t think the surge in COVID-19 cases will derail the global equity rally as vaccine expectations have solidified with the promising trial results of the various manufacturers involved in the moonshot mission.

Global Stocks: COVID-19 losers lifted by vaccine

European equities (Euro Stoxx 50, +18.1%), the most battered because of the extent of COVID-19 lockdown measures this year, led global stocks higher in November (MSCI ACWI, +12.4%) as vaccine news brought forward the normalization of economic activity. Europe outperformed most regions last month, followed by a strong performance from Japanese equities (Nikkei 225, +15.1%), another Value proxy market. Emerging equities (MSCI EM, +9.2%) lagged as Asia EM countries have been better shielded from COVID-19 disruptions in recent months, most notably in China. Similarly, U.S. stocks slightly underperformed (S&P 500, +10.9%), but still maintain a strong year-to-date lead over other regions because of their tech dominance, which is best reflected in the Nasdaq 100 (+11.1%).
With interest rates well anchored by central banks that are fueling a public-debt binge, vaccine news did little to Canadian interest rates in November. The yield on Canada’s 10yr bond was steady and ended the month at 0.67% (from 0.66%). Oil prices, however, jumped nearly $10 per barrel (pb) as the vaccine means a boost to oil demand in coming months. All combined, the loonie benefited from better risk sentiment and ended the month at $0.77, the highest in 2020, even as Canada is running a highly expansionary fiscal policy with a deficit approaching $400bn, or about 20% of Gross Domestic Product (GDP), combined with a rising trade deficit. With equity headwinds dissipating, anxiety has come down sharply and the VIX volatility index ending the month at 20.6%, the lowest since February.

Equity Factors: Vaccine shot helping some, but not all

With investors starting to see the light at the end of the COVID-19 tunnel, Value (+14.7%) stocks outperformed global stocks (MSCI ACWI, +12.4%),while Low-Volatility (+7.0%), which have also disappointed year-to-date, continued to lag as Low-Volatility companies typically exhibit a lower dependency to the global economic and profit cycle. Small-Cap (+14.3%) was the only other factor outperforming global stocks in November.

With the vaccine helping to normalize economic activity, we continue to think Small-Caps look more attractive and sustainable than Value stocks as a reflation play through equity factors. In a growth-starved world that is accompanied by global excess supply, slow economic growth, and low interest rates, Value companies have faced relentless disruption from New-Economy stocks that are leading the world leaping onto digital transformation. Technology adoption is accelerating not only because COVID-19 is restricting social mobility, but also because of how technology is enabling new firms to quickly emerge and grow by transforming even the oldest industries—think of Tesla, which has disrupted century old car makers, or Uber, which caused an earth quake to the transportation.
In Canada, Low-Vol (BMO Canadian Low-Volatility Equity ETF, ticker: ZLB, 9.2%) also rose sharply but lagged the broad BMO S&P TSX Capped Composite Index (ticker: ZCN, 10.8%) in a month where the energy sector (BMO Equal Weight Oil and Gas Index ETF, ticker: ZEO, +24.3%) surged and banks (BMO Equal Weight Banks Index ETF, ticker: ZEB, +14.3%) nicely outperformed as the worse of the credit concerns are in the rearview.

Vaccine Tide More Likely to Lift all Boats than Fueling Sustained Sector Rotation

Good news on the vaccine front has prompted a more convincing market repricing, as presaged by higher oil prices and long-term yields in the U.S. In turn, the most battered, cyclical sectors—energy and financials—outperformed in November. While short covering is partly to blame, the outsized moves reflect a significant rotation toward cyclicals and value, as indicated by flow data. Long-term beneficiaries of the COVID-19 shock (info tech and communication services) were not exactly left in the dust, with each posting solid 10% gains in November while still outperforming other sectors. On a sour note, real estate continued to underperform, a sign that markets have yet to price in a return to normal as certain headwinds may persist. These include work-from-home schemes and reduced business travel, in addition to a slow labor market recovery, all which impact office, hospitality and residential REITS.

Upon positive vaccine developments, we think overweighting higher-beta and cyclicals look tactically attractive. Longer-term, however, energy and financials will continue to face headwinds even as the COVID-19 storm is largely behind us. Structurally low interest rates and weak global growth will continue to weigh on margins for financials, while oil markets are likely to face persistent demand headwinds related to consumer behavior, environmental regulation and the electric vehicle revolution. These factors can explain why analysts’ EPS growth projections have not been revised meaningfully higher for cyclicals such as energy, industrials and financials. Meanwhile, sectors such as info tech, healthcare and communications, which benefit from COVID-19-induced tech advancements, remain at the top of the pack.
For investors seeking to participate to the vaccine-fueled global reflation, we think investors should focus on overweighting global stocks rather than position for sector or factor rotations, which appear more uncertain than the expected equity outperformance versus fixed income in 2021.

Outlook and Positioning: Dialing-up global equities

With the U.S. election uncertainty in the rear-view mirror and the vaccine rollout getting underway, we increased our equity overweight a notch and trimmed our fixed-income exposures. While equities have enjoyed an impressive rally since the March lows, we think equities have room to run as the economic recovery will likely extend well into 2022, supported by aggressive fiscal stimulus.
Elsewhere, our positioning remains unchanged with an overweight to U.S. and EM equity markets, funded by Canada and EAFE. We continue to prefer IG corporate bonds to Federals or riskier high-yielding bonds. We are maintaining a small duration overweight as a hedge against downside on our increased equity stance. While the loonie has surprised us to the upside in recent months, its ascent continues to evolve in the global context of a weaker U.S. Dollar. Unlike equities, however, currency prices are relative measures, and as such there are limits to how high the loonie can fly, notably because of the meaningful rise in the twin deficit.
Happy and safe holiday season from the MAST team.


* The performance for (ZLB) for the period ended November 30th, 2020 is (as follows: 0.95% (1 Year); 6.60% (3 year); 8.30% (5 year); and 12.29% since inception (on October 21st, 2011).
**The performance for (ZCN) for the period ended November 30th, 2020 is (as follows: 4.38% (1 Year); 5.56% (3 year); 8.26% (5 year); 5.79% (10 year); and 6.84% since inception (on May 29th, 2009).
***The performance for (ZEO) for the period ended November 30th, 2020 is (as follows: -24.16% (1 Year); -16.16% (3 year); -8.80% (5 year); -7.82% (10 year); and -6.96% since inception (on October 20th, 2009)
****The performance for (ZEB) for the period ended November 30th, 2020 is (as follows: -1.91% (1 Year); -2.67% (3 year); 8.93% (5 year); 9.11% (10 year); and 9.69% since inception (on October 20th, 2009)
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