October Monthly MAST Commentary: COVID-19 Catching President Trump, U.S. Politics, and Second-Wave Anxiety Temper Euphoria, not Optimism

  • We think equity markets will bring higher-than-normal volatility as we head into the elections, but equities remain attractive relative to bonds when looking beyond the 3- to 6-month horizon.
  • Election uncertainty is elevated, but the widening lead of Biden over Trump should help, allowing market participants to shift focus back to the economic recovery and the pandemic.
  • We update our outlook for Emerging Markets (EM) equities. We think they will benefit from both short-term and long-term developments such as the pandemic itself and post-COVID-19 reflation trades, given its exposure to Asia and the significant dose of tech within its universe.
  • Our portfolio positioning has been We modestly overweight stocks versus bonds and prefer U.S. and EM markets over Europe, Australasia, and the Middle East (EAFE) and Canada. We have a modest tilt toward bond duration and prefer Investment Grade (IG) to High Yield (HY).

One of the extraordinary things about human events is that the unthinkable becomes thinkable.

Salman Rushdie

Global equities registered a disappointing performance in September, but the macro news confirmed the recovery was well underway and lost ground is being recovered relatively fast. But virus resurgence in Europe and North America, coupled with the fear of a chaotic U.S. Presidential election and difficulty to pass another round of fiscal help before the election, chilled investors’ euphoria. Housing activity, the most significant positive surprise during this COVID-19 recession which so far underpins the consumer-led recovery, continued to surprise to the upside both in Canada and the U.S.

Investors have been concerned about a contested U.S. election, but the widening lead of Biden over Trump has reduced that likelihood, although President Trump catching COVID-19 has added some uncertainty. However, diminishing risks of a contested election should allow investors to shift focus back to the economic recovery and the pandemic. Finally, we don’t think a Democratic sweep would be as negative as some fear, notably on the tax front where we doubt the corporate tax rate could go all the way up to 28%, as 25% seems more likely.

Speed Bump for Global Stocks, but Fundamental Story Intact

Global stocks (MSCI ACWI, -3.2%) ended a streak of five positive months in September as U.S. stocks underperformed. Nasdaq 100 (-5.7%) stocks led the underperformance and the mega-cap tech pulled down S&P 500 (-3.8%). European stocks were broadly down as well, but to a lesser extent (Euro Stoxx 50, -2.3%; German DAX, -1.4%; UK FTSE 100, -1.5%) although the region faced a surge in COVID-19 cases. Canadian equities (-2.1%) slightly outperformed global peers despite a 11.7% drop for the energy sector. Emerging markets (MSCI EM, -1.6%) were slightly down due to a pullback in Chinese companies. Finally, Japanese (Nikkei, +0.8%) shares was a rare bright spot last month as investors felt reassured that the newly elected Prime Minister Yoshihide Suga would purse stimulative policies.

Yields on long-term government bonds moved in a tight range in September but edged lower on second-wave anxiety. The yield on Canada’s 10yr bond was little changed (from 0.62% to 0.56%). In signs of a plateauing rebound for oil demand and lingering excess supply, West Texas Intermediate (WTI) oil prices retreated (-5.6%) to $40.20 per barrel (pb) and without further production cuts, we think oil prices will struggle to move beyond the mid-$40 level in 2020. Gold prices had a rocky month (-4.2%) as risk assets were under pressure, which benefited the greenback (DXY, +1.9%) on a flight to safety. The loonie fell back to $0.75, a move in line with other currency majors. Finally, the VIX volatility index peaked at 33.6% early in the month and continues to reflect higher than normal investor anxiety ahead of the U.S. election, with peak stress priced around the election.

Equity Factors: All moving in sync

The relative performance of global equity factors was quiet last month. Growth (-3.3%), Momentum (-3.2%) and Value (-3.1%) were the weakest, while Quality (-2.5%) and Low-Volatility (-1.6%) were just marginally ahead.

In Canada, equity factor performance was more eventful as TSX sectors registered a wider dispersion in September. In a month of negative performance for the broad BMO S&P TSX Capped Composite Index (ticker: ZCN, -2.1%)*, Low-Volatility (BMO Canadian Low-Volatility Equity ETF, ticker: ZLB, +1.1%)** outperformed by a decent margin. Most of the outperformance can be attributed to the negative performance of the energy sector (BMO Equal Weight Oil and Gas Index ETF, ticker: ZEO, -13.9%)*** and banks (BMO Equal Weight Banks Index ETF, ticker: ZEB, -4.8%)****.

Although oil prices have been depressed lately, energy stocks seem to feel pain above and beyond that reflected by oil prices. We think this is possibly due to a challenging combination of investor fatigue as the industry is bleeding billions, the fear that a Biden presidency would hurt the industry, and due to the gradual divesting trend brought by greater Environmental, Social, Governance (ESG) scrutiny.

Chart 1: Energy Companies Feeling Pain Beyond WTI Oil Prices

Chart 1: Energy Companies Feeling Pain Beyond WTI Oil Prices

Source: Bloomberg, BMO GAM (as of October 2nd, 2020)

EM Outlook: Supplying the consumption binge of developed economies

One reason we have overweighted EM equities since the COVID-19 outbreak is that not only are these countries first in, first out with respect to the first wave, but they are better equipped to handle subsequent outbreaks. Recall that the top three countries in MSCI EM—China, Taiwan and South Korea—compose 63% of the index and are also the top performers this year. “Test, track and trace” strategies used in these countries resulted in less stringent lockdowns and rapid containment. In China this has allowed for a faster, more V-shaped recovery and less economic scarring. Fiscal stimulus targeting infrastructure spending in China also helped. Overall, a call on MSCI EM equities is a call on Asian equities, which continue to outperform partly on better COVID-19 control.

We also like EM because of its higher weighting to the IT sector—a key beneficiary of COVID-19 and of the ongoing theme of tech disruption—which has contributed to Asian EM outperformance (see Chart 2). We believe the sector’s stronger earnings trajectories; higher quality balance sheets and COVID-accelerated tech adoption will continue to power this sector forward. Recall that semiconductors were the sole global sector to post a positive gain in September (0.8%) despite ongoing trade tensions and the risk off tone.

Chart 2: Equity Indices with Higher Share of IT Performed Better in 2020

Chart 2: Equity Indices with Higher Share of IT Performed Better in 2020

Source: BMO GAM, Bloomberg (as of October 1st, 2020)

U.S. dollar (USD) depreciation is another tailwind for EM assets. The drop in the U.S. real yield advantage opens to door to further USD weakness, while economic recoveries—the phase of the cycle we are currently in—are generally USD negative, benefiting EM flows. Finally, we believe the U.S. election result, which still favors Biden, will also be USD negative. A Biden victory, particularly a Democratic sweep, could be USD negative by lowering trade tensions and global policy uncertainty, which have strengthened the dollar since 2018.

For these reasons, EM equities are an attractive tactical and strategic asset, benefiting from both short-term and long-term developments. Moreover, even though the first wave of COVID-19 is behind us, we think EM equities are still a good play going forward. Economic momentum is on track for a strong recovery in H2, led by China, while EM central banks still have room to cut rates unlike developed countries. A successful vaccine has mixed implications for EM by prompting a rotation to the most battered areas, like cyclicals, value or Europe. Yet COVID-19 uncertainty is likely to continue even upon successful trials of a vaccine as unknowns over effectiveness and deployment remain. We like exposure to regions that are effective in living with the virus. But on an eventual return to post-vaccine normalcy, we also prefer the EM space which will benefit from continued tech dominance, global growth normalization and USD depreciation, more so than other regions like Europe which have structural growth impediments and lack tech leadership.

Outlook and Positioning: From bouncing to grinding

The stance of our portfolios is steady and remains positioned for very modest tilts toward a risk-on cycle. When looking beyond the U.S. election, we think the fog will disappear enough to justify a stronger equity stance, but we are not there yet. The positive backdrop from fiscal and monetary stimulus is intact, but the virus resurgence and the election noise will likely cap near-term equity optimism. Our modest overweight to stocks versus bond is unchanged, as well as our intra-equity overweight to U.S. and EM, funded by Canada and EAFE. Similarly, we maintain a steady preference for IG corporate bonds to riskier high-yielding bonds while bond duration remains attractive in Canada. Finally, persistent market anxiety, depressed oil prices, and economic growth that’s ever more dependent on housing and fiscal support, we think the loonie has limited upside over the mid-term outlook.


*The performance for (ZCN) for the period ended September 30th, 2020 is (as follows: 0.07% (1 Year);
3.48% (3 year); 7.14% (5 year); 5.50% (10 year); and 6.30% since inception (on May 29th, 2009).

**The performance for (ZLB) for the period ended September 30th, 2020 is (as follows: -3.70% (1 Year); 5.58% (3 year); 7.06% (5 year); and 11.70% since inception (on October 21st, 2011).

***The performance for (ZEO) for the period ended September 30th, 2020 is (as follows: -37.40% (1 Year); -21.19% (3 year); -10.69% (5 year); -8.95% (10 year); and -8.50% since inception (on October 20th, 2009)

****The performance for (ZEB) for the period ended September 30th, 2020 is (as follows: -11.05% (1 Year); 0.01% (3 year); 7.05% (5 year); 7.94% (10 year); and 8.54% since inception (on October 20th, 2009)

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