As always, please let us know if you have any questions.
This week, as of writing markets appear to be rebounding after a fairly routine short-term pullback, which is something we have been expecting. Remember, these short-term resets and tests of market strength are healthy nuances of the market. Russ Visch, BMO’s Technical Analyst, confirms “the character of the decline in terms of the breadth, volume, and sector performance is exactly what we would expect to see during a [short-term] pullback”. From a technical perspective, both markets have very little standing in the way of another push higher longer term, but we may see a brief test of the lows again before doing so. As of writing, the market seems to be testing previous highs from last month, but has not been able to break through. We will be watching for a breakout in either direction. Short-term and long-term we are still fully invested in the Green Zone.
As mentioned in our annual newsletter, which should have arrived in the mail by now, we have made some adjustments to our strategy that will reduce the amount of transactions in your accounts, while still being very active. This past month, we have maintained our discipline. We continue to hold only the strongest relative positions, drilling down to the strongest asset class, geography, sector, industry, and company. Technology, Basic Materials, Industrials and Consumer Non-Cyclical remain the top sectors, as they remain stronger given the late stage market cycle we are in and more importantly that these sectors benefit in this Covid environment.
Volatility has been relatively stable this month, but spiked higher than average this past week. This increase in volatility has likely been amplified by end of month pension rebalancing, share option expiries, and news relating to Covid. The roll out of vaccines globally has been slower than expected and closer to home the primary concern has shifted from distribution to supply. With these delays comes a continued strain on small private businesses that have been forced to stay closed, compete with online retail giants, and rely heavily on government financial aid.
The message on financial stimulus south of the border is changing. Last month we saw growth in the market, in part due to anticipated financial stimulus from the new democratic government. The market typically starts to price in and react to what is expected six to twelve months in the future. However, now that it is looking like a lower budget will be approved, we are likely to see the market adjust as the numbers continue to be re-calculated. Financial stimulus actions and news will likely be a continued theme throughout 2021 that will have swaying impacts on the market.
Another factor to watch for is inflation, which is anticipated to be higher than typical, though only slightly beyond expectations. With respect to inflation, we share comments from the BMO Global Asset Management Inflation Report
“The U.S. Federal Reserve stated that in 2021, they will allow inflation to run beyond its 2% target, with no hard ceiling specified. ...Today, the market (which is forward-looking) is pricing in an average annual inflation rate of about 2.1% for the next five years, which is roughly in line with the Bank of Canada’s (BoC) and the U.S. Federal Reserve’s (the Fed) initial inflation target of 2%. Many indexes notched new highs to close out 2020 signalling the market has priced in an economic recovery and predicts growth in the new year, and with growth comes inflation.”
Interest rates are a concern for many, as we will eventually see an increase that will place strain on those holding debt and will decrease the fixed income market. Historically, governments have not increased rates until the economic outlook improves and for the time being we do not expect to see any change. However, to mitigate our risk from a fixed income perspective we continue to hold PIMCO, one of the largest fixed income managers in the world, which actively seeks out the best positions globally. We have also shifted focus to debt with shorter-term commitments, as they will be less negatively impacted by increases in interest rates.
GameStop, BlackBerry, and Silver share spikes have captivated news outlets recently, as they represent what some believe to be a change in the investment rules. What drove up the share price of these companies, with little to no intrinsic value, is a massive online community effort to create a buying spree of individual stocks. This online community realized that many financial institutions sold call options on struggling companies, as a way to profit when the share price fell. They also realized that if they bought enough call options on these companies, the financial institutions would have to buy stock to cover themselves on the calls they sold. With enough buying volume, this drove the stock price higher and ultimately these individuals benefited at the loss of the financial institutions. GameStop for example increased from $20 to $500 a share, a massive overvaluation of the company that was completely disconnected from any level of fundamental company analysis. This is a drastic example of how a stock can move in a completely different direction than expected, even after analyzing all available information, and why it is important to supplement fundamental analysis with technical analysis. Technical analysis, and more specifically the Relative Strength strategy that we use, allows us to objectively see the strength of a stock regardless of the cause. There will always be information that is not readily available, especially as global connectivity through technology continues to grow, making it all the more important to have a diligent strategy that encompasses both fundamental and technical analysis.