Multi-Asset

The Re-Opening Game is Starting

Across Europe and North America, efforts toward re-opening the economy are mounting and the normalization goalposts are becoming real with the pandemic getting under control.
May 2020

It would be wonderful if we could avoid the common setbacks with timely exits.

Peter Lynch

Across Europe and North America, efforts toward re-opening the economy are mounting and the normalization goalposts are becoming real with the pandemic getting under control. Without more sophisticated tests and trace models (Source: Bloomberg)[i], or more evidence that medical treatments (Source: Bloomberg)[ii] could reduce the strain on healthcare systems, investors will remain anxious. This explains why our overweight to stocks has been kept modest and cautious in recent weeks.

Economic normalization will take time, but because stock valuation depends not only on near-term earnings, but also cash flows in coming years, it’s not surprising to see stocks recover more quickly than economic activity—though the rebound from the March lows has been surprising.

COVID Increases Equity-Return Dispersion

For tactical-asset allocation to generate alpha, markets must exhibit enough dispersion. While equity volatility is sharply higher since the beginning of the U.S.-China trade tensions before spiking even more with COVID fear, monthly correlations across major international stock markets also increased (Chart 1).

Chart 1: Rising Correlations Across International Equity Markets

Chart 1: Rising Correlations Across International Equity Markets

Source: Bloomberg, BMO GAM (April 30th, 2020)

Despite elevated correlations; however, the dispersion of returns has also picked up, giving rise to alpha opportunities (Chart 2). While predicting COVID-like shocks is impossible, some persistent macro investment trends have remained intact this year. The outperformance of U.S. equities has continued during the historical COVID market turmoil. We have been overweighting U.S. stocks versus EAFE for several months, and our view remains intact that this trend will run further as we exit COVID. The U.S.’s tech leadership could accelerate in a post-COVID, increasingly digital world.

After accounting for currency fluctuations, U.S. stocks have outperformed EAFE by over 800 basis points (bps) in 2020. Keep in mind that Nasdaq 100 stocks are up couple percent in 2020 while some major equity markets are still down more than 20%.

Chart 2: Dispersion Across Global Equity Markets Creates Alpha Opportunities

Chart 2: Dispersion Across Global Equity Markets Creates Alpha Opportunities

Source: Bloomberg, BMO GAM (April 30th, 2020)

Not a Day Goes By without Billions in Stimulus

Between the fiscal and monetary response, stimulus keeps on pouring. Central banks are aggressively expanding their balance sheets while governments are spending to help workers and businesses cope with COVID. The U.S. Federal Reserve’s (Fed) balance sheet has exploded above $6.5tn, or about 25% of GDP. The Fed’s balance sheet could even reach 50% of GDP before COVID is behind us. For the Bank of Canada, its balance sheet stands at about $350bn, or 15% of GDP up from 5%. Meanwhile, the U.S. fiscal boost has broken above $3tn whereas the Canadian fiscal response amounts to approximately $450bn.

Portfolio Update: COVID Uncertainty, Zero Interest Rates and Helicopter Money to Make Gold Shine

Last week, we strategically and tactically introduced an allocation to gold in some of our portfolios. We believe there is no better macro environment for adding gold. First, economic normalization is a highly uncertain process and gold provides a time-proven safe-haven if the re-opening is derailed by a second COVID wave. Second, zero-interest-rates policies mean the cost of carry is minimal. Third, in contrast to monetary policy, history demonstrates that massive deficit spending has a stellar track record at stimulating demand and generating inflation, during which period’s gold usually shines.

Disclosures

[1] https://www.bloomberg.com/news/articles/2020-04-10/apple-google-bring-covid-19-contact-tracing-to-3-billion-people?sref=0W2IFhIJ

[2] https://www.bloomberg.com/news/articles/2020-04-29/gilead-remdesivir-trial-for-covid-19-has-met-primary-endpoint?sref=0W2IFhIJ

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