Perhaps our most well anchored thesis of the last decade was a geographical bias to U.S. equities. This tilt proved fruitful in 2020 as American companies continued their growth leadership over Canada, Europe and Emerging Markets. Now, as the vaccines promise an end to the pandemic era, the focus may return to valuations, with some analysts claiming that price-to-earnings ratios are “too high.” We see no cause for immediate alarm though. Our long-term forecasts show that relative to key variables – such as growth, interest rates, inflation and inflation expectations – the broad U.S. equity market is priced within reason.
We also benefitted from foreign currency exposure to the US dollar, which soared relative to the loonie when investors panicked last year and flocked to the familiar safe havens. There were notable gains in risk-off assets in February and March. However, after the volatility quelled, the Canadian dollar joined other currencies in regaining some ground – a trend that could continue as the economic situation normalizes and commodity prices rebound.
Looking ahead, we continue to believe there is value in a U.S. bias, though not perhaps as much as previously expected. Average GDP growth in the past 10 years has been approximately 2.5% per year, whereas it was closer to 3.5% in the decade preceding the Great Financial Crisis. This decline has been worrying. Also, it’s important to note that the country’s aging population contributes to slower growth, and forces companies to compete for market share rather than reaping the rewards of organic expansion. With the economic pie growing less quickly, we expect lower alpha from this trade going forward.
At the same time, we have been very impressed with how EM countries handled their COVID-19 response plans. China, in particular, was so successful in quickly controlling the virus that it will likely have less scarring in the economy and even saw its economy grow 2.3% in 2020. This dovetails with our overweight exposure to EM, which we returned to last year as shipping lanes reopened and trade began to pick up in Southeast Asia. Meanwhile, we have yet to see such positive developments in Europe, which continues to face significant headwinds related to weakened demand, Brexit, and a new rampant strain of the virus.