Off the Lows, but Seatbelt Fastened

Just when the caterpillar thought the world was over, it became a butterfly.

Zen proverbs

An increasing number of indicators are confirming that the worst of the March-April economic contraction is behind us, but equity prices did not wait to see a bottom in economic activity and earnings before bouncing off their lows. With the Volatility Index (VIX) near 30, it’s hardly a complacent market as the market-implied fear gauge reflects that investors expect 8-9% in monthly swings for the S&P 500 until year end. Finally, last week Fed Chair Jerome Powell said the Fed “[will] keep at it until work is done with job market”, basically telling investors he had their back.

Job Market Off the Lows, Starting Long Healing Process

After an abysmal loss of 3 million jobs between March and April, the Canadian job market surprised economists with a gain of 290k jobs in May as some regions were gradually re-opening. U.S. payrolls also surprised with 2.5mm jobs. With the re-opening process moving ahead, we expect June data to show an even stronger rebound in payrolls. However, the full healing of the job market could lag the broader economic recovery as many firms are struggling to survive and must repair their balance sheet. The intensifying digitalization possibly means less demand for labour in a post-COVID world.

Value, Small-Caps Bouncing Off the Lows, but Resisting “Great Rotation” Calls

The U.S. Value and Small-Cap equity factors have significantly lagged the broad market into May, but they rebounded strongly late May and early June as the equity rally finally gained breadth instead of being pulled by a handful of stocks (Chart 1). We think investors should remain cautious of the weaker segments of the markets as the full extent of the COVID collateral damages will endure at least until the end of 2020, and probably late into 2021 or beyond. The ongoing wave of defaults and bankruptcies will likely drag on for a while and this recovery will be more about healing rather than booming times.

Chart 1: Value and Small-Cap Stocks Getting a Bit of Love

Chart 1: Value and Small-Cap Stocks Getting a Bit of Love

Source: MSCI, Bloomberg, BMO GAM (as of June 10, 2020)

Consumer Confidence is Off the Lows

Consumer surveys which plunged in March and April stabilized in May. What’s more, levels of consumer confidence have been relatively resilient compared to the depths of the global financial crisis (Chart 2). The Conference Board survey for example, which is more tied to labour market conditions, is well off its 2008-2009 lows and has seen a much smaller hit to expectations than to sentiment over current conditions.

Chart 2: U.S. Consumer Confidence Has Plunged but Remains Well Above GFC Lows

Chart 2: U.S. Consumer Confidence Has Plunged but Remains Well Above GFC Lows

Source: Haver, BMO GAM (as of June 10, 2020)

We think this reflects the temporary nature of the layoffs and the substantial income support from federal programs. As of May, 73% of unemployed workers in the U.S. were on temporary layoff, while at least 60% of those receiving unemployment benefits now have a larger income than before the COVID outbreak. A bottoming in consumer confidence and gradual improvement from here is a key development for investors.

Portfolio Update: Equity allocations drifting higher along with market rally

After having to buy equities to rebalance our portfolios, the strong equity rally took our equity allocations a little above our target weights in recent weeks. Further equity upside could trigger a rebalancing where we would sell equities to buy bonds, but we remain comfortable with our modest equity overweight.


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