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Q news – second quarter 2020
The objective of Q news is to help you understand our services as well as clarify, educate and invite your questions.
As we continue to move through the COVID-19 pandemic I hope that you and your family are healthy and doing well. I also wish that you are finding new ways to cope and hopefully finding a silver lining where you can. As we are now sending this newsletter digitally there is a clickable link in this newsletter.
"In investing, what is comfortable is rarely profitable." –
Robert Arnott- founder and chairman of Research Affiliates, a subadvisor to PIMCO
The 2nd quarter of 2020 started during what was almost certainly the most uncomfortable period for equity investors since the financial crises. By the end of the quarter many indices saw double digit gains with the NASDAQ making an all time high.
Are stocks overvalued?
While admitting that there is a wider range of outcomes than there normally might be PIMCO seems to think that equities are fairly valued in this environment. This is not intuitive given the state of the world economy at the moment. In such unprecedented times, instead of relying solely on long-term valuation anchors, PIMCO has utilized an approach that attempts to incorporate both sides of the argument. In the following graph, they show the result of a simple regression analysis to gauge the current state of equity valuations in light of central bank actions and expectations of economic health. PIMCO uses U.S. data for this exercise given longer available history to estimate whether the S&P 500’s price/earnings (P/E) ratio (the relative price of stocks) is rich or cheap given the level of 10-year real yields (as a proxy for central bank action and overall policy support) and consumer sentiment (as a proxy for perceived economic health), also incorporating the rate of inflation.
In this analysis, equities valuations were observed to be cheap for most of the last decade, as low real yields and expansion-level confidence stayed ahead of the rally, and had just hit “fair” in early 2020. Then the sharp sell-off in the first quarter of 2020 dragged equities to record-cheap levels as the market correction was greater than what would have been predicted by the loss of confidence alone. The subsequent rebound has been very strong considering that confidence remains depressed.
“We’re not thinking about raising rates. We’re not even thinking about thinking about raising rates.”
This quote from Jerome Powell’s (Chairman of the Federal Reserve Bank of the United States) June 12 meeting sums up monetary policy around the world at the moment. Money will continue to be cheap and liquidity will be provided via quantitative easing for the near future. Forecasts for how the economy will recover have been changing weekly but consensus is forming. Asia and Europe are ahead of North America in both their recovery from COVID-19 and the subsequent economic rebound. The latest numbers from Europe provided by BMO Economics are encouraging.
Source: BMO Economics
Visual Capitalist provides an interesting chart here highlighting how various larger countries are progressing through this crisis.
Canada’s conservative approach seems to be paying off. Our Chief Economist Doug Porter reports that this week brought yet another round of dramatic numbers, but especially so in Canada. Some were extremely positive, such as the 952,900 June job gain and the big bounce in housing activity, while others were very negative, such as a $343 billion projected budget deficit. Even with this mixed bag, the broader picture is that the Canadian economy continues to claw back steadily from the April depths, at a pace towards the upper end of expectations. However, overhanging that relatively sunny news is the persistent and unnerving surge in U.S. virus cases, which is now also translating into a moderate rise in mortalities. With more than 60,000 daily new cases, that’s running roughly 20 times higher than in neighbouring Canada on a per capita basis. The rising U.S. case count clipped Treasury yields (taking 10s to 0.6% for the first time since April), halted the rally in oil (pulling WTI back to $40), and kept stocks in check (although the S&P 500 edged up, while the Nasdaq hit new highs.
BMO Economics latest projections on GDP show what this recovery might look like in North America;
Source: BMO Economics
Any wealth planning opportunities?
In light of the Bank of Canada’s reduction of the overnight lending rate from 1.75% pre COVID-19 to 0.25% as of March 27th there are certainly a few opportunities. Should you have the opportunity to renegotiate any debt in this environment please reach out to us to see if we can help.
As of July 1 this year the CRA has lowered the prescribed rate to 1% from 2%. Dante Rossi and our BMO Wealth Planning Group point out that this low 1% rate can be “locked-in” for any prescribed rate loans implemented during this period, as this rate of interest will apply throughout the term of the loan, regardless of any rate changes in the future. 1% is the lowest rate that the CRA will allow so this is a change that would most likely be done only once.
Should you have any prescribed loans in place currently at a higher rate or are considering income splitting through a prescribed rate loan we would be happy to work with you and your tax professional to evaluate these types of strategies.
Can we avoid market drawdowns? Should we?
The success of market timing has been proven to be random time and time again. Successful investors base their asset allocation decisions on comfort with volatility and time horizon. In fact, the attempt to market time and avoid drawdowns can be nothing short of disastrous. What do you think would have happened if you were able to avoid being invested in equities in all the years in which the markets had a loss of 5% or more at some point during the year and invested this money in bonds instead (5-year U.S. Treasuries)? How would you have done versus another investor who held onto their equity investments, bumpy ride and all? The chart below shows how this would have played out from 1950 to 2018.
Source: Edgepoint, Bloomberg LP
If you were able to avoid all the years in which the stock market fell by at least 5%, and invested in bonds during those years. By 2018 you would have accumulated 90% less in your account than a buy-and-hold strategy. The reason? You would have been invested in equities in only six years!
Survival of the fittest
We have just been through the steepest, deepest, and fastest recession in history, but there are clear indications that the North American economy has begun the first stages of recovery. Workplaces have gradually started to reopen, consumer spending, construction, and manufacturing are beginning to revive. However, with some restrictions still in place, and many North Americans understandably reluctant to venture out (specifically in certain parts of the US), a full recovery will likely take an extended period of time. In particular, there are a variety of sectors that could face an extremely rocky road over the next year, and may never fully return to prepandemic levels. As well, the loss of confidence, wealth, and employment prospects from the swift downturn will keep some households and businesses cautious in their spending plans. Some areas of the economy will never return to normal. Many of us (including BMO) have already received communications from our employers that working from home will be our option in the future. This trend was already in place but has certainly been accelerated by the COVID-19 disruption. Commercial real estate will most likely suffer but I can assure you the view from a potential penthouse condo on the 72nd floor of First Canadian Place would be spectacular and command a high per square foot price. I am being somewhat facetious but the effects of technological unemployment have been debated since the time of Aristotle. You could imagine that the invention of the wheel replaced labourers at a minimum of 1 for 4. BMO Economics put together the following table to forecast what might happen to the various sectors of the economy going forward compared to what they looked like at the end of 2019.
Family Office Services
We are here to help so please do not hesitate to engage us when you are contemplating estate, tax, insurance or asset protection planning. These activities should all be integrated for the most efficient and effective result. Should you have friends, family or colleagues that require some guidance in these areas please do not hesitate to put us in touch. If we feel we can help we will provide a comprehensive path forward for them without pressure, commitment or cost.
On behalf of David and Hayleigh please enjoy the rest of the beautiful summer weather and as we approach stage 3 of reopening here in Toronto may we all be thankful for the small things we all used to take for granted!
Associate Portfolio Manager
It’s a privilege to assist you and your family.
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