President Trump’s trade-war tactics surprised markets once again by threatening Mexico with tariffs if Mexico could not limit the flow of migrants to the U.S. Such an unorthodox move disappointed investors on the prospects for a trade deal between the U.S. and China, and drove global equity markets lower in May.
Global stocks (MSCI ACWI) were hit hard (-6.2%) as the S&P 500 lost 6.4% while the Nasdaq 100 fell 8.2% as concerns over the fear of the negative impact from trade wars culminated alongside softer macro-economic data releases. Elsewhere, it was also tough in Japan (-7.4%) and in emerging markets (-7.5%) as hope for a trade truce melted with rising tariffs on China and other U.S. trading partners. Canadian stocks were down too, but only -3.1% as investors perceive Canada as being less exposed to trade wars, a point which we address below. The downbeat investor sentiment shook off oil prices last month as WTI (West Texas Intermediate) oil prices lost 16.5%.
Renewed recession fears fueled demand for safe haven assets. The yield on 10-year government bonds collapsed a full 38bps and 22bps in the U.S. and Canada, respectively. Globally, the sum of negative-yielding debt in bond issues hit 11 trillion USD. Late May, several segments of the U.S. yield curve went into inversion, but the 2-10 yield curve was relatively stable. The curve has steepened early this month on rising odds for an imminent Fed rate cut. In Canada, the inversion is deeper as the overnight cash rate yields more than all maturities up to 30 years. Finally, the loonie lost nearly a percent driven by the sell-off in oil prices and risk-off sentiment, which dominated the improving macroeconomic data. The Canadian job numbers are very good this year with gains of +222k from January and April.
Low-Vol Equities Helps on Slippery Roads
Global equity-factor styles showed a lot of dispersion in May, but the stories behind some of the relative movements is not that clear. Quality (-6.4%) and Size (-6.8%) were the hardest hit compared to the less severe losses experienced for Growth (-5.7%) and Momentum (-3.6%), which is the opposite of what we would usually expect in a typical risk-off environment. However, Low-Vol (-1%) outperformed every other factor by a significant margin, as expected in this uncertain environment. More interestingly, a simple equal-weighted factor-based portfolio would have generated nearly 130bps of outperformance relative to a traditional benchmark. The Low-Vol factor remains our favourite factor tilt in this highly uncertain environment.
In Canada, Low-Vol (ticker: ZLB, +1.2%) shined when the broad market (ticker: ZCN, -3.1%) suffered losses as oil tanked. As part of an investor’s Canadian equity holding, we believe that investors should consider a strategic allocation of 10% to 20% to the Low-Vol factor as a way to mitigate the influence of the more volatile energy sector and instead focus on stocks with lower market beta. We think this view is supported by both strategic and tactical considerations.
Tariffs are not “Beautiful” for Equities, But Canada Well Positioned
Since Trump’s May 5th tweet, trade tensions have shown limited signs of resolve and if anything have escalated, which left equities in the red in May. The most trade-exposed sectors underperformed across North American equities, notably energy, info tech, materials, industrials, and consumer discretionary. These key categories are targeted or threatened by Trump tariffs. Most of these sectors have also underperformed on a year-to-date basis. Furthermore, looking at a basket of firms most exposed to revenues from Asia shows that these firms also underperformed the benchmark.