Multi-Asset

February Monthly MAST Commentary: Strong Economic and Earnings Momentum to Finish 2020

Economic and earnings momentum continues to improve faster than expected in North America and Asia.
February 2021
  • The pace of new COVID-19 cases has diminished in most regions while vaccines rollout is facing some temporary supply challenges. We continue to expect +50% vaccination rates by the summer in most major economies.
  • Economic and earnings momentum continues to improve faster than expected in North America and Asia, while the Euro-area economy is at risk of a double dip recession because of more aggressive mobility restrictions and less direct stimulus.
  • We continue to think small-cap stocks are best positioned to benefit from fiscal stimulus, notably in the U.S. where economic growth keeps outperforming expectations.
  • Our conviction remains strongest toward expectations for global stocks to outperform bonds. Regionally, we still prefer U.S. and Emerging Markets (EM) equities over Canadian and Europe, Australasia, and the Middle East (EAFE) markets to benefit from a U.S.- and China-led reflation play, while overweighting Investment Grade (IG) corporate bonds versus low-yielding government bonds.

A learned fool is more a fool than an ignorant fool.

Moliere

January delivered some good news to investors, particularly on the virus front as new COVID-19 cases declined significantly in most countries. However, the vaccination rollouts saw delays, notably in Canada where the pace came to a crawl and left Canada severely lagging on the vaccination rate. Although temporary issues have slowed vaccine supplies, we continue to expect +50% vaccination rates by the summer in most major economies. Despite ongoing mobility restrictions due to COVID-19, economic activity surprised strongly to the upside in Canada as fourth quarter GDP growth could be as high as 8% (annualized), thanks to strong consumer spending and booming real-estate activity. In the U.S., fourth quarter GDP growth also came in strong at 4%, while survey data point to a robust Q1. By early February, over half of the S&P 500’s market cap reported fourth-quarter results and 80% companies have beaten expectations. As the world continued to adjust to COVID-19 reality, mega tech registered a blockbuster quarter driven solid growth in digital businesses.

WallStreetBets and the Art of Guerrilla Speculation

Euphoria around reddit’s WallStreetBets’ retail army led to an epic short squeeze on a few small-cap stocks, especially for GameStop whose stock price gained 1625% in January, after surging 572% between its April low and 2020 year-end. Unlike the S&P 500, whose market cap is skewed toward a few mega companies, the Russell 2000 index remains more diversified and the surging market value of GameStop and other heavily shorted companies had little impact on the overall strong performance of the broader U.S. small-cap space–besides causing severe losses to a few hedge funds which had piled into short positions of the company. This kind of guerrilla trading, characterized by organized speculative attacks of possibly millions of small retail investors on heavily shorted companies, has enjoyed the effect of surprise, but we think this has created more noise and distractions. Investors should keep a closer eye on the improving fundamentals and resilience of the global economy.

Global Markets: Good news not enough to lift equities

Global equities (MSCI ACWI, -0.4% in January) kicked off 2021 on a soft note despite the better-than-expected earnings and broad declines in new COVID cases. Most regions were slightly negative, except for East Asian markets. From Hong Kong (Hang Seng, +3.9%), China (MSCI China, +7.4%) to South Korea (Kospi, +3.6%) or Taiwan (+2.8%), the region is thriving on strong domestic economic resilience during the pandemic and the is additionally thriving from strong exports of tech goods to

the world. This positive dynamic led the MSCI EM index to a 3.1% gain for the month. In the U.S., the S&P 500 (-1.0%) was slightly down, but Russell 2000 (+5.0%) shares extended their strong rally on expectations that U.S. small-cap companies are best positioned to benefit from the upcoming vaccine- and stimulus led economic recovery. European (Euro Stoxx, -1.9%) markets were the weakest region in January as rolling waves of the pandemic delay the economic recovery, even putting the Euro-area economy at risk of a double-dip recession. Finally, Canadian (S&P TSX, -0.3%) stocks were about flat for the month.

The steady improvements of the economy are helping modestly lift long-term interest rates in Canada and the U.S., but central-bank commitment to ultra-loose monetary policy has prevented a V-shaped rebound in long-term interest rates, in sharp contrast to stock prices. The yield on Canada’s 10yr bond grinded higher to end the month at 0.89% (from 0.68%). The uptick in interest rates was enough to leave benchmarked fixed-income assets down for the month (BMO Aggregate Bond Index ETF, ticker: ZAG, -1.1%)*. Optimism trickled to oil prices which climbed to $52.20 (from $48.52) as oil inventories, which remain elevated due to weak demand, nevertheless continued to trend lower in recent weeks.

After steadily declining since April, the Greenback (U.S. Dollar Index, +0.7%) rose a bit as the U.S. economy is showing clear signs of decoupling from other major economies where lockdowns have taken a steep economic toll. The loonie was barely down as the strong fiscal stimulus drove the economy to a sugar-high into year end. Finally, the late month softening, sentiment of equity investors drove the VIX volatility index rose back to 33%, a clear sign that investor sentiment and positioning remains highly cautious despite aggressive policy support and the vaccines rollout. We think this lingering layer of moderate fear will eventually abate into the Spring and will help support further equity upside this year.

Global Equity Factors: Momentum keeps its momentum

Global equity factors performed in a tight range las month, except for Momentum (+3.7%). Global Low-Vol (-1.9) lagged last month while other styles were marginally down, including small-caps. Interestingly, the regional divide saw U.S. (+3.8%) small-caps outperform Canadian (+0.4%), European (+0.4%) or Asia-Pacific (-0.1%) small-caps in January, which we think reflects expectations for further aggressive U.S. fiscal stimulus and stronger economic growth into 2022.

Similar to their global peers, Canadian Low-Vol (BMO Canadian Low-Volatility Equity ETF, ticker: ZLB, -1.9%)** stocks underperformed in January as the energy complex (BMO Equal Weight Oil and Gas Index ETF, ticker: ZEO, 2.8%)*** outperformed, helped by recovering oil prices. Upcoming bank earnings could surprise to the upside as credit stress continues to abate, trading activity remains higher than average, and real-estate activity and credit demand booms. However, with the latter two drivers of earnings already running high, it’s hard to envision a sustained outperformance as we saw in late 2016-2017 when interest rates were trending higher given that short- to mid-term interest rates remain well anchored.

Time to Fear Higher Inflation and Interest Rates?

The better-than-expected economic performance of Canada and the U.S. in recent months has led some investors to wonder if higher inflation and interest rates were around the corner. Although economic activity has recovered faster than most expected, it’s largely due to the war-like fiscal deficits. We expect the combined federal and provincial deficits in Canada to be near 25% of GDP in fiscal-year 2020, and possibly more than 10% in 2021. While such deficits usually rhyme with hot inflation, we don’t think inflation will run hot enough to make central banks eager to hike interest rates anytime soon as the economy remains in healing mode. We think central banks will continue to err on the side of caution and maintain their aggressive support of the economy while bond purchases should diminish somewhat proportionally to diminishing fiscal deficits.

For fixed-income heavy investors, this means the biggest threat is not to see a sudden spike in interest rates, but they could struggle to keep up with inflation in the next 12 to 24 months as inflation accelerates and eats into purchasing power. As the economy returns to some normalcy, we expect a modest grind higher in long-term interest rates, but nothing to derail asset-price valuation as we expect positive earnings momentum into 2022.

Outlook and Positioning: Vaccination tide will lift all markets

Last month, we reduced our underweight of Canadian equities against the U.S. as our bullish conviction on global equities outperforming bonds grows stronger than our regional preferences. Vaccination will be the tide that lifts all markets. We remain slightly overweight U.S. and EM equity markets versus Canadian and EAFE markets. Our steady pro-risk stance maintains an overweight to IG corporate bonds to Federals, while we are hedging against downside surprises with a small duration overweight.

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Disclosures

* The performance for (ZAG) for the period ended January 29th, 2021 is (as follows: 4.28% (1 Year); 5.37% (3 year); 3.73% (5 year); 4.20% (10 year); and 4.21% since inception (on October 21st, 2011).

**The performance for (ZLB) for the period ended January 29th, 2021 is (as follows: -3.62% (1 Year); 6.16% (3 year); 7.93% (5 year); and 11.71% since inception (on May 29th, 2009).

*** The performance for (ZEO) for the period ended January 29th, 2021 is (as follows: -21.77% (1 Year); -13.11% (3 year); -6.72% (5 year); -8.36% (10 year); and -6.47% since inception (on May 29th, 2009).

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