Returning to normal in the COVID-19 era

The time is always right to do what is right.

Dr. Martin Luther King, Jr.

Cases and deaths in the U.S. and Canada continue to drop as businesses continue to reopen, underpinning recent risk-on sentiment. Yet fears of second waves remain strong, especially as protests escalate. There is, however, encouraging evidence that suggests any second wave could be relatively contained and, more importantly, not lead to nationwide shutdowns. Social distancing has worked to bend the curve while fatality rates are well below previous estimates. Estimates on infection fatality rate, as opposed to case fatalities, could be as low as 0.25% in the U.S. according to the CDC, or even lower as antibody testing ramps up because of the high share of symptom-free cases. 

Finally, positivity rates, or the share of positive tests out of total tested, have fallen below 4% in Canada and to 5% in the U.S., reaching the WHO-recommended target threshold. What’s more, the U.S. hotspots of New York and New Jersey are even lower at 3-4%. Outside of those regions, it cannot be overlooked that the virus was relatively contained (beds and ICUs were well below capacity). Overall, second waves, should they materialize, may not lead to widespread shutdowns, not least because of the costly disruption for businesses and local governments. The virus may not be as deadly as previously thought, and is highly concentrated geographically and demographically, allowing policymakers to give greater weight to the economic costs of shutdowns.

Chart 1: Positivity Rates (Positive Tests out of Total Tests)

Chart 1: Positivity Rates (Positive Tests out of Total Tests)

Source: BMO GAM, Health Canada, JHU. (June 1, 2020)

Equity Risk Premium Increasingly Important Tailwind for Stocks

In a near-zero interest rates world where global government bonds provide sub-inflation yields, investors now largely like them for their diversification and downside protection benefits as return expectations have collapsed with yields. For instance, if the yield on Canada’s 30-year Federal bond fell to zero by year end, investors would get a +25% price appreciation from falling rates. For long-term investors, however, the longer-term return expectations matter more than the tail-risk scenarios of a sharp drop in yields or equities. Both the equity risk premium (earnings yield minus the 10-year Treasury yield) and the excess dividend yield (dividend yield minus the 10-year Treasury yield) of the S&P 500 are are supportive of equities vs bonds.. The earnings yield will likely compress further in 2020, but it will still look attractive when compared to near zero government bond yields.

Chart 2: S&P 500 Equity Risk Premium and Dividend Yield Favoured By Capped U.S. Treasury Yields

Chart 2: S&P 500 Equity Risk Premium and Dividend Yield Favoured By Capped U.S. Treasury Yields

Source: Bloomberg, BMO GAM (June 1, 2020)

Portfolio Update: Setting up for more opportunities with fixed-income markets

Within our ETF portfolios, we exchanged units of ZAG for underlying units of the nine sector ETFs that make up the broader aggregate Canadian bond market, composed of Federal, provincial and corporate debt, each with their own duration range. With this more granular set of exposures, we will have efficient means to make strategic and tactical allocations within the fixed-income portion of our ETF portfolios. For instance, we will be able to tweak our corporate bond exposures while making duration adjustments or capture a higher coupon yield through provincial bonds as we did in March in some portfolios. We also believe this will help us in this environment where market liquidity for corporate bonds remains challenging.


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This article is for information purposes. The information contained herein is not, and should not be construed as, investment, tax or legal advice to any party. Investments should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance.

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