By Sadiq S. Adatia, Chief Investment Officer Sun Life Global
Despite a global economy ravaged by COVID-19, major indexes surged to record highs.
Highlights
Joe Biden wins November’s U.S. presidential election
Democrats take control of Congress after winning Georgia Senate race
A second wave of COVID-19 surges globally
U.S. passes $900-billion stimulus package
Major indexes including the S&P 500 hit new highs
Canada, other nations begin COVID-19 vaccinations
Britain and European Union (EU) reach last minute Brexit deal
Oil prices increase to US$48 a barrel from US$39
U.S. dollar retreats; Canadian dollar climbs from US$0.75 to US$0.78
The S&P 500 bookended 2020 with record highs at the start and end of the year. In between, COVID-19 swept across the world, triggering the sharpest decline into a bear market in history. Economies shut down; millions of people lost their jobs. If that wasn’t enough, markets had to digest a disputed U.S. election, with an angry president sowing chaos. Still, vaccines arrived; President-elect Joe Biden promised a calmer White House and Congress finally delivered a $900-billion stimulus package. With that, markets ended a very tough year on a roll, with investors looking beyond a slowing economy and COVID-19’s deadly second wave.
Even with the vaccines’ promise, we still have a long way to go. A year after the virus emerged in China, nearly two million people have died worldwide. This, as the pandemic’s second wave accelerates with new variants emerging. (Chart 1). And many questions remain. For one, will vaccine supply and distribution problems continue? Will enough people get vaccinated to reach herd immunity levels, generally around 70% of the population? Perhaps most importantly: as the virus continues to mutate, will it trigger a third wave and more lockdowns?
Markets rallied on positive vaccine news. But just after quarter-end, they had to weigh the outcome of another critical election – this time for two Senate seats in Georgia. November’s presidential vote resulted in a gridlocked Congress with neither party in control. This outcome could have prevented the enactment of policies that the market didn’t want, such as tax increases. Surprising though, Democrats won both contests, resulting in a 50-50 tie in the Senate with Vice President-elect Kamala Harris holding the tiebreaker vote. While this might open the door to higher taxes, it could also lead to additional fiscal stimulus. In response, value and cyclical stocks rallied, spiking the Dow to a record high while interest rates rose on the prospect of more rapid growth.
Chart 1: Virus continues to surge worldwide
Daily new COVID-19 cases, 7-day moving average
Source: World Health Organization, Johns Hopkins University, SLGI Asset Management Inc. Data as of December 31, 2020.
Growing more positive on 2021
Over the course of the year, we believed three things had to happen to move the market higher. First, we needed to get the contentious U.S. election behind us. Second, vaccines had to be approved and rolled out. Third, a U.S. stimulus package was required to keep the U.S. recovery on course. Overall, with all three now in place we feel more optimistic as we head into 2021.
This is not to say it will be clear sailing. Far from it. The virus is still running rampant in many countries including the U.S. with nearly 20,000 new cases a day. Nor is the economy bouncing back as quickly as many had hoped, and we could see a further slowdown in the first quarter. However, on the positive side, corporate earnings may remain strong. In fact, based on our current market outlook, we could see market returns in the high single or possibly even double digits by year-end.
Still, there is this important caveat: it all depends on a smooth, rapid roll out of the vaccines. As noted, if there are widespread side effects, lack of people taking it or distribution problems, it would certainly change our view. Hopefully, none of this will occur.
Shifting from growth, keying on value
Overall, we entered 2021 with an overweight position in U.S., emerging market and international equities. And for the first time in many months, we were more positive on Canada – moving from underweight to neutral.
However, we did trim our position in U.S. equities back to a small overweight in Q4. Major tech companies (including the so-called FAANG stocks) with exposure to the work-from-home play, led the market off the March bottom. They also accounted for much of the S&P 500’s gains in 2020, and we took advantage of this rally. At the same time, many value stocks were hurt when the economy shut down. But as Q4 progressed, and in anticipation of a U.S. stimulus package, value began to recover. New money flowed into materials, energy and financials. In fact, late in the quarter, U.S. banks got a boost when stress tests showed they had adequate capital reserves, allowing them to again initiate share buybacks and issue dividends. The sector could also be helped further if yields slowly rise in 2021 as we expect.
We also believed that the U.S. would get a stimulus package, and took down our position in large-cap growth companies from overweight to neutral. As we did, we added value names, which ultimately outperformed growth in the fourth quarter. We also increased our mid-and small-cap exposure, with the latter also out performing large-cap growth stocks (Chart 2).
Now with the roll out of vaccines and further stimulus, we could see the shift into value accelerate as the broader market recovers. To participate, we will continue to use a barbell strategy. On one side to manage short-term risk, we are holding large U.S. growth names with an emphasis on active management. On the other, as noted, we’ve added value categories like industrials, materials, and small- and mid-cap stocks. In addition, we have made a number of tactical options trades in value sectors, including industrials and financials.
Chart 2: Value, catching up with growth
As we have throughout the year, we maintained our overweight exposure to emerging markets. The MSCI Emerging Markets Index closed the year at a new high. Even so, we believe it has more room to run in 2021 as the global economy potentially recovers further.
However, the speed of the recovery from the COVID-19 recession has varied widely across emerging markets. Countries like China, South Korea and India have the expertise to contain the outbreak. They are also wealthy enough deliver stimulus programs and have fared better. In fact, Bloomberg forecasts a 9% and 8.1% growth rate for India and China respectively in 2021. By comparison, it predicts the global economy could grow by 4 to 6%.
Overall, emerging market countries with import dependent economies could benefit from a weaker U.S. dollar. As well, the in-coming Biden administration may take a less combative stance with China. On top of that, China (which now has minimal COVID-19 cases) has developed and deployed its own vaccine. Russia has as well, but it has failed to contain the virus.
In terms of international equities, the economic drag created by the seemingly intractable Brexit negotiations ended when the EU and Britain finally reached a comprehensive trade deal. As well, late in December, China and the EU announced the signing of a major trade deal. It would give both greater access to their respective economies.
While that might be a cause for optimism, it was offset by COVID-19’s second wave. It continues to devastate a number of European countries. Indeed, at one point, Britain, which is under lock down, was recording over 50,000 new cases a day. Still, Britain has been inoculating its citizens against the virus at a faster rate than the U.S. and Canada. As well, the European Union launched a mass vaccination program to inoculate all its adult population by the end of 2021.
We also expect continued stimulus from the EU and European Central Bank. However, while equity valuations are more attractive than the U.S., we are still cautious, and we reduced our position to a small overweight.
For the first time in over a year, we turned somewhat positive on Canada – moving from underweight to neutral. The S&P/TSX Composite Index performed well in 2020 despite the pandemic, low oil prices and high consumer debt levels. Still, with large parts of the country in lockdown, it likely hurt economic growth in Q4, which could spill over into Q1, 2021.
However, as the market recovery broadens out, we believe the S&P/TSX Composite Index could perform better in 2021. This, given its large exposure to metals, mining, financials and oil. All of which may do well in a post-pandemic world. We are particularly optimistic about oil, which could see demand pick up as the economy reopens.
Low interest rates – the hunt for yield
Depending on where you stood, you either loved or hated 2020’s rock bottom interest rates. On one side, they helped fuel the equity rally. On the other, they vexed investors looking for yield and the concomitant ballast for their portfolios. There is little relief in sight. Indeed, with little or no inflation and with millions still unemployed, both the U.S. Federal Reserve and Bank of Canada have made it clear they expect low rates to continue for perhaps as long as three years.
Against that backdrop, we are underweight investment grade bonds, in favour of equities. However, with the Fed continuing to back the category, we are overweight high yield corporate bonds. As well, given the improving economic outlook in many developing countries, we are positive on emerging market debt.
Overall, in Q4 the yield on U.S. Treasuries started the quarter at 0.68% and ended at 0.93%. By comparison, Canadian 10-year bond yields were at 0.55% the start of the quarter and moved to 0.81%. As we get deeper into 2021, we expect bond yields to slowly grind higher. This, as economic stimulus wanes and the appetite for risk improves (Chart 3).
Chart 3: Preferring corporates for higher yields
Source: Macrobond. Data as of December 31, 2020.
U.S. dollar falls, loonie rises – adding gold
With a softer U.S. dollar and the Fed’s promise to keep interest rates low, we have been hedging the currency. Moreover, we believe the Canadian dollar may continue to appreciate against the greenback, possibly surpassing US$0.80 in 2021.
We could see inflation start to emerge, possibly late in 2021. But we don’t believe we’ll see strong inflation soon. Still, the market will react to any perceived inflation threat. To that end as a hedge, we added exposure to gold and silver in our Sun Life Tactical ETF Portfolios. As well, they hold treasury inflation protected securities, or TIPS.
Major indexes rally to new highs
In Q4, the S&P 500 continued to rally off the March bottom, finishing up 18.4% at a record high. During 2020, forward 12-month PE ratios on the S&P moved from 18.25 to 22.69. By some measures, the S&P 500 is considered expensive, trading above its 16.01 median level going back to 1990.. But it is still below the 25.30 peak it reached in Dec. 1999.
Equity strength in Q4 was not restricted to the U.S. The MSCI World Index also hit a new record high up 14% in 2020 The MSCI EAFE Index was up 9.1% for the year, also a new top. The MSCI Emerging Markets Index also rallied, finishing up 18.69% on strong capital inflows. (Chart 4). At home, the S&P/TSX Composite Index rose 5.6% in 2020, led higher by consumer staples and materials. But it still closed below the record pre-COVID-19 high it set on Feb. 20 (Chart 5).
Chart 4: Equities: strength heading into 2021
Total return, indexed to 0 as of January 1, 2020
Source: Bloomberg. Data as of December 31, 2020.
Canada: improving as the year progresses?
For our part, we agree with the Bank of Canada’s economic outlook. It suggests that we could see negative growth in the first quarter. However, if the vaccine rolls out as predicted, growth may rebound in the spring as business and consumer spending starts to pick up. Indeed, based on the median projection from private-sector economists, Canada’s real GDP could rise by 4.4% in 2021. That compares to an estimated 5.7% decline for 2020.
There are positive economic signs. Corporate earnings are at a two-year high. And oil prices have rebounded to the US$50 a barrel range from US$40. Some forecasts suggest it could go as high as US$60 if the global economy recovers and COVID-19 retreats in the coming months.
Canadian consumers are also flush with cash. This, because of federal government support programs and weaker consumption. Indeed, Bank of Montreal estimates that higher savings rates have risen to the equivalent of 6.8% of GDP ($151 billion). If consumers start spending this money, which the government refers to as “pre-loaded” stimulus, it could have a significant impact on the economy in 2021.
On the negative side, as we entered Q4 Statistics Canada estimated that nearly 1.7 million Canadians remained unemployed. And government support programs, including aid to individuals and businesses, is expected to run out in the spring. At that point, we could see a rise in bankruptcies with more layoffs.
Chart 5: Consumer staples lead S&P/TSX Composite
Source: Bloomberg. Data as of December 31, 2020.
Stimulus could accelerate U.S. recovery
Since the onset of the pandemic, we believed that the U.S. had the capacity to inject additional fiscal stimulus into the economy. Late in Q4, we finally saw that happen, with the U.S. Congress passing the $900-billion economic-rescue package. Now, with Joe Biden in the White House and Democrats in control of the White House and Congress, we could see further stimulus in the months ahead.
Even before the passage of the stimulus package, a number of U.S. economic indicators were improving. Consumer spending had nearly returned to pre-COVID-19 levels. And average household income had surpassed it. Another key indicator, the ISM Manufacturing PMI for the U.S. jumped to 60.7 in December from 57.5 in November. This was above forecasts and the strongest growth rate since August of 2018.
The latest round of economic stimulus could accelerate this recovery. Economists, including from the Federal Reserve, had already predicted that U.S. GDP would grow between 4 and 6% in 2021. They also believe we will see a contraction of 3.5% n 2020. For our part, as noted, we expect a slow start to the year. But as the vaccines rollout, and with the latest round of stimulus kicking in, we expect the economy to improve.
Emerging markets: China, India bounce back
The rally in emerging market equites that we saw in Q4 was driven by a number of factors. These included, improving investor sentiment and the promise of both continuing low interest rates and on-going fiscal stimulus.
Indeed, two bellwether emerging market countries, China and India, posted solid growth in Q4. In November alone, China’s customs agency reported that the country had shipped US$268 billion in exports, up 21% over the same month in 2019. This was largely due to the export of technologies in areas where demand increased during the pandemic – including in the work-from-home space. Chinese stocks also closed out 2020 at their highest level since 2008.
It was a similar story in India. The country’s HIS Markit Purchasing Managers Index rose to 58.9% in October, versus 54.6% in the previous month – its strongest increase in nine years. India equity markets also recovered, with MSCI India reaching an all-time high.
However, as noted, emerging market countries are bifurcated between those that can manage the pandemic, deploy large amounts of stimulus and have low exposure to hard-hit sectors. For example, in December Bloomberg forecasted 9% growth in India in 2021 and 3.5% for Brazil and South Africa.
This difference is also reflected in the ability of emerging market countries to deliver the vaccine. Some, again including India and China, plan to vaccinate large swaths of their populations in the second and third quarters. However, others could be on hold until early 2022.
International markets: finally an end to Brexit
Europe ended Q4 bookended between good and bad news. On the positive side, EU manufacturing rebounded in Q4. But the pandemic’s second wave triggered widening lockdowns in major European countries, including Britain, France and Germany.
Even so, manufacturing activity increased at its fastest pace since 2018 in Q4. The European IHS Markit Manufacturing Purchasing Managers' Index, rose to 55.2 in December from November's 53.8. (Anything above 50 indicates growth.) Part of the increase was attributed to a manufacturing rebound in Germany, the continent’s largest exporter.
That said, unemployment levels remained largely unchanged in Q4. But the consensus view still suggests European economic growth will reach pre-pandemic levels in early 2022.
As for Brexit, it is still uncertain what effect the agreement will have on the U.K. and EU economies. However, from a British perspective, many economists are pessimistic. Indeed, Citygroup suggests Britain’s economy could produce 2% to 2.5% less in 2021 than it would have it they remained in the EU. Over the long term, the bank also predicted Brexit could do more damage to the U.K.’s economy than COVID-19 has.
Outlook: overweight equities, underweight bonds
Overall, we were slightly overweight equities in Q4. Within our equity mix, we were overweight U.S., emerging market and international equities. In fixed income, we preferred equities over investment grade bonds.
Slightly reduced our overweight position in U.S. equities.
With a shift in value/cyclicals, moved from underweight to neutral on Canada.
Maintained a small overweight position in MSCI EAFE equities.
With major emerging market economies recovering, maintained our overweight position.
Hedged the U.S. dollar on weakness, expecting further strength in Canadian dollar.
Overall, we will continue to manage risk in the short term while looking for longer-term opportunities. However, for now, we are comfortable with how the Sun Life Granite Managed Portfolios are positioned.
This article contains information in summary form for your convenience, published SLGI Asset Management Inc. Although this article has been prepared from sources believed to be reliable, SLGI Asset Management Inc. cannot guarantee its accuracy or completeness and is intended to provide you with general information and should not be construed as providing specific individual financial, investment, tax, or legal advice. The views expressed are those of the author and not necessarily the opinions of SLGI Asset Management Inc. Please note, any future or forward looking statements contained in this article are speculative in nature and cannot be relied upon. There is no guarantee that these events will occur or in the manner speculated. Please speak with your professional advisors before acting on any information contained in this article. © SLGI Asset Management Inc. and its licensors, 2021. SLGI Asset Management Inc. is a member of the Sun Life group of companies. All rights reserved. Sadiq S. Adatia, Chief Investment Officer
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