360 Private Wealth Management: 2020 Q3 Market Commentary
Global markets saw continued recovery during the summer, followed by a pullback in September.
In Canada, the S&P/TSX Composite Total Return Index continued its rebound before stumbling in September, finishing with a return of 4.7%, including dividends, in the third quarter. Following the sharpest quarterly economic contraction in GDP on record, U.S. equity markets continued their strongest rally from a bear market in history. The S&P 500, Dow Jones and Nasdaq all surpassed their pre-COVID highs, respectively jumping 8.9%, 8.2% and 11.2% in U.S. dollar terms, on a total return basis during the third quarter. In overseas markets, international equities rallied 4.9 % in U.S. dollar terms as measured by the MSCI EAFE Index, including dividends, during the same period.
As discussed previously, it is important for investors to dig a little deeper into the index data before celebrating too much. As discussed in an earlier commentary, markets have bifurcated (split) dramatically over the last several months, dividing into sectors and companies benefitting from the circumstances created by the COVID-19 pandemic and sectors and companies being severely impacted by the fallout of the pandemic. Market indexes are being skewed by the significant increase in valuations of the supposed COVID “winners” including the tech, health care and consumer staple stocks against the continued stagnant valuations of the sectors and companies most adversely affected. Much of the actual “recovery” in the market indexes we’ve seen has been driven by the very narrow group of company stocks that have benefited from the circumstance surrounding the COVID pandemic. Most of the rest of the market, except the carbon energy sector, have recovered modestly from the lows experienced back in March but are generally trending sideways below their previous highs. Investors are waiting for a vaccine or proven treatment options before recommitting to the sectors and companies most likely to benefit most from a return to some sort of normal.
An important question for investors is how over-valued the COVID winners might currently be after being driven to such high valuation. There is a very real danger for investors chasing the winners that market physics may take over and bring the values of these sectors and companies back down to earth when businesses and consumers resort to more normal behavior patterns. A surge in stocks hurt by the COVID situation will be offset, at least somewhat, by the return to earth of the COVID winner valuations. If this comes to pass (and there are plenty of past situations showing it will!) then indexes could trade sideways, even while the more affected sectors and companies actually move higher in value. Investors could be as rewarded for being in value stocks (those sectors and companies currently treading water) when vaccines and treatments emerge as they were by the COVID winners in the height of the pandemic. Those overweight the COVID winners when this transition occurs may give back a chunk of their paper gains if they are not agile. Such a scenario is quite possible and even very highly likely over the next couple years…
Here’s a look at some of the issues that made their mark in the third quarter:
- Coronavirus. Worldwide markets reacted to improvements in COVID-19 case counts for much of the third quarter. The U.S. economy started to reopen and recover and is, right now, likely no longer in a recession. We’re starting to see the much anticipated second wave of COVID-19 cases in Canada, the U.S., Europe and other regions. Uncertainty over what the economic consequences will be, and the potential for a vaccine and its global distribution will likely lead to increased volatility. The fact remains that in order for people and economies to get back to any sense of normal, we need viable vaccine or treatment candidates. Until then, there will likely be continuing bifurcation of investment markets.
- Seasonality. September is typically the worst month in terms of performance, and this year was no exception. Since 1950, September has recorded the worst monthly return on average for the S&P 500 Index. International equities also wavered during September.
- Oil. The price of oil was essentially flat for the quarter, at approximately US$40 a barrel as measured by West Texas Intermediate (WTI). A continued lower demand for crude is likely to keep prices below their 2020 highs and continues to be a definite drag on the energy sector.
- Interest rates. Global central banks continued their monetary policy support, maintaining short-term interest rates at or near historical lows.
- Geopolitical issues. Renewed fears surrounding the Brexit deal hampered returns across Europe, while better than expected economic data out of China during the third quarter, buoyed equity markets in Asia. Renewed trade tensions between China and the United States, and the upcoming U.S. election contributed to volatility.
Investment markets may be more volatile in the next several weeks with the U.S. election in November. This said, any significant weakness in the markets should be viewed as a buying opportunity. In the years immediately following an election, the S&P 500 has averaged 11.4%, regardless of the election outcome. We need to remember to put political emotions aside when making investment decisions. Economies in democratic countries may not operate in a vacuum but they are often more affected by economic metrics than they are by elections. In fact, right now economists and analysts generally agree that there will likely be little immediate change in government policies affecting markets in the short term regardless of who wins the election. Biden is more of a centrist than a liberal based on his past history as a senator. He likely would gain no real benefit from taking policy dramatically to the left as far as the economy is concerned. So, if the Biden-Harris ticket win most economists and investment analysts think it will be largely steady as she goes in the near term. Those prospects are likely to improve in 2021 and 2022 because of COVID-19 vaccines and treatments emerging… Looking further out though, the candidates offer very different social and economic agendas which will reward different sectors and businesses, depending on who wins the White House, if the candidates are successful in implementing their policies. Success will depend on who wins the House of representatives and the Senate. A sweep by the Democrats is possible. If that happens the agenda will likely be more progressive from an environmental and social perspective. This could reshape the U.S. economy and by extension, the North American economy faster than what might be the case otherwise. Investors would be wise to pay attention!
The great pause caused by the initial wave of COVID-19 has given way to a recovery, but we believe this recovery will be choppy. We don’t think there will be another complete shutdown like we experienced in the spring, even as the second wave of COVID cases appears to be upon us. The arrival of anticipated vaccine and treatment candidates will add relief and hope to the equation which should create a positive atmosphere for equity investments in general again. If this comes to pass, we should expect market returns to be average over the next twelve months.
A bright light in the near term may be in emerging markets, as earnings momentum is stronger in China, Korea, and Taiwan than elsewhere in the world. China, Korea and Taiwan seem to have dealt with COVID-19 better than many other countries and regions. Their economic output is already surging again.
Selectivity and a long-term outlook will be the keys to successful investing globally and here at home. While trying not to sound too optimistic (serious issues and risks still lurk!) we believe we will be well on the path to economic recovery by the end of 2021. This should bode well for broader investment markets as well.
As always, if you have questions about the markets or your investments, I’m here to talk.
David J. Luke, CFP, RFP, CLU, CH.F.C., CIM | Financial Advisor
360 Private Wealth Management | Manulife Securities Incorporated
Unit 1 – 25 Scurfield Boulevard, Winnipeg, MB R3Y 1G4
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This publication is solely the work of David Luke for the private information of his clients. Although the author is a Manulife Securities Advisor, he is not a financial analyst at Manulife Securities Incorporated (“Manulife Securities”). This is not an official publication of Manulife Securities. The views, opinions and recommendations are those of the author alone and they may not necessarily be those of Manulife Securities. This publication is not an offer to sell or a solicitation of an offer to buy any securities. This publication is not meant to provide legal, accounting or account advice. As each situation is different, you should seek advice based on your specific circumstances. Please call to arrange for an appointment. The information contained herein was obtained from sources believed to be reliable; however, no representation or warranty, express or implied, is made by the writer, Manulife Securities or any other person as to its accuracy, completeness or correctness.