As Canada continues to ease restrictions following a decline in new COVID-19 cases, optimism is on the rise for many getting back together with family and friends, getting back to work, and getting back to something resembling their normal lives. Global financial markets have rallied strongly from March lows on the back of the unprecedented monetary and fiscal stimulus provided by policy makers around the world. As restrictions ease around the globe, we are seeing evidence of stabilization and improvement in economic indicators, albeit from the very low levels experienced earlier in the year.
But the virus continues to spread
Despite seeing declines in new cases in areas that were initially hit hardest – East Asia, Europe, and the north-eastern U.S. – worldwide cases continue to climb at an increasing pace. Latin America (Brazil, Chile, Mexico, Peru, Ecuador), South Asia (India, Indonesia), and South Africa are all regions reporting elevated infection rates. There is a real concern that the healthcare systems of these developing countries may get overwhelmed.
As the epicenter shifts to emerging markets, the U.S. is also seeing an alarming reacceleration in new cases, particularly in regions that previously avoided the worst of the first wave in March and April. Texas, Florida, Arizona, and California have reported significant increases, in many cases, setting new records. More concerningly, hospitalizations have also been trending upward in at least 14 states. This obviously raises concerns of a second wave, even before the first one has ended.
The sharp reacceleration in new cases in many parts of the U.S. (which is perceived to have relaxed restrictions early) suggests we need to be cautious. After China fought off the first wave, new cases have sprung up in Beijing after going 55 days without reporting a new infection. With over 300 new cases since June 11th, China has reinstated several restrictions within the city. Unluckily, following its announcement that it was COVID-19-free and lifting all domestic restrictions, new cases (related to travel) were diagnosed in New Zealand, ending its 24-day infection-free streak. It’s neighbor Australia, which also had success reigning in the spread of the virus, is now battling an outbreak in 10 Melbourne neighborhoods that saw 75 new cases
It is likely that the virus will be with us for the foreseeable future – until we develop a vaccine or discover an effective treatment. We will need to continue to be vigilant.
For political and economic reasons, the will for additional lockdown measures is fading
Despite the rise in new cases and hospitalizations, for weeks Florida Governor Ron DeSantis, Texas Governor Greg Abbot, Treasury Secretary Steve Mnuchin and President Donald Trump have all expressed that there would be no new lockdown measures, or at least they would be a last resort. That said, Florida, Texas and Arizona have been forced to partially reverse some opening activities, as their healthcare systems approach capacity.
It’s not only the U.S. that has expressed this sentiment. South Africa remains committed to loosening restrictions, as is India, to support the economy, despite rising daily infections. Europe is relaxing intra-European travel in efforts to support the travel and tourism economy.
It is not our purpose to judge policy maker decisions as right or wrong, but rather to assess what their likeliest course of action will be and how it would impact our positioning. With that said, it seems unlikely that everyone will shelter-in-place until a vaccine or treatment is developed which, despite the extraordinary effort of the global medical and scientific community, is potentially years away. Extreme lockdown no longer appears politically and economically viable. Going forward, we expect to see targeted regional restrictions ebb and flow in response to their local situations.
At the same time, we are clearly far from “normal” – emergency stay-at-home orders are easing, but day-to-day activities are likely to remain pandemic-considerate for the foreseeable future. Activities like dining in restaurants, theatres, sporting events, conventions, international tourism, and even office work are all unlikely to return to normal anytime soon.
This will continue to present economic challenges for businesses like hospitality, travel and restaurants that are not profitable when operating at a fraction of capacity. These typically labour intensive business will unfortunately continue to struggle, putting pressure on labour markets, which will weigh on consumer spending.
Policy makers recognize this and have responded decisively with continued support. In Canada, we’ve seen the extension of the Canada Emergency Response Benefit (CERB). In the U.S., a US$1 trillion infrastructure stimulus package is being considered.
Some additional indirect considerations include the de-globalization trend and rising geopolitical tensions between the U.S. and China in particular.
Proceeding with cautious optimism
With lockdown measures biased towards easing and economic activity at very low levels, we are within the recovery phase of the business cycle, often an opportunistic time to invest.
While Canada has pushed through the first peak of the pandemic, the fact remains that we are still in a health crisis. A second and even third COVID-19 wave continues to be a real threat, which is why we continue to be cautious in positioning client portfolios.
The aforementioned fiscal and monetary stimulus has significantly improved the situation and policymakers appear committed to seemingly do whatever it takes to get through the pandemic without a severe health crisis, economic crisis, and financial crisis. So, while moral hazard is ripe, “don’t fight the Fed” (or the European Central Bank, the People’s Bank of China, the Bank of Japan, or the Bank of England, the list goes on) remains sound investment advice.
At this time, another crash in financial markets comparable to what was experienced earlier in the year is not in our base case. At the same time, we recognize the unique health, policy, and economic challenges ahead of us. The success of policymaker actions has led financial markets on a robust rally, suggesting the strongest gains may be behind us, particularly in equity markets.
We scale our positioning for relative opportunities as well as perceived risk. While we don’t expect a major drop in financial markets, we want to be in a position to capitalize if one does materialize. Therefore, we are presently only modestly overweight equities in our tactical asset allocation, rounded out with positions among relative countries (at this time we prefer developed North American equities relative to international and emerging market equities), currencies, and interest rate positions which should provide some protection should the unexpected arise. Keep in mind, we are not set in our positioning and are constantly assessing new information in this fluid environment that could change our current positioning.
Within our equity portfolios, we are assessing our holdings (typically higher quality companies with stronger balance sheets and financing flexibility) carefully to ensure risks, and potential volatility, are at an appropriate level.
Fixed income is the asset class most directly impacted by policymaker activities as central banks have actively suppressed interest rates (and signaled that they will continue to do so) to support their respective economies. At this time, we have increased our allocation to higher yielding credit instruments.
As we continue to fight the pandemic together, I wanted to take this opportunity to thank those on the frontlines for serving and protecting us. We will continue to be prudent in assessing current conditions and making the appropriate adjustments if and when necessary.
For more information, please contact your MD Advisor*. She or he would be happy to answer any questions you may have.
* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec).
The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice nor is it intended to replace the advice of independent tax, accounting or legal professionals.