EQUITIES COMMENT: "Black and Blue"
Equity investors are feeling bruised after the first quarter of 2020. Global stocks reached record highs in the middle of February however, when news hit that the coronavirus was spreading outside of Asia, markets began one of the fastest and largest declines of the last century. The breakdown of OPEC+ added to the weakness in stocks. Short term traders hit the sell button while buyers stepped aside to await further clarity on the fallout from the pandemic. This resulted in a lack of liquidity that contributed to a sharp fall in prices. Volatility spiked to record levels, surpassing those recorded during the financial crisis. This fueled more selling. At times like this, owning high quality, large cap dividend paying stocks ensures that investors are receiving a steady stream of income and can take comfort in knowing these businesses have made it through tough times before, often emerging stronger on the other side. For the quarter, the TSX fell 21% while the S&P 500 (-12%) and MSCI EAFE (-15%) fared better in Canadian dollar terms. U.S. and international stocks benefitted from the weakening of our dollar and lower exposure to the hard hit energy sector.
“Gimme Shelter” Looking at the sectors of the Canadian and U.S. markets, there was no safe harbour during the March storm. All had negative returns with Energy being most impacted. Less affected were consumer staples (grocery stores), communications (internet and wireless), utilities (critical infrastructure) and technology (computer software and social media). Two other points are worth mentioning: In U.S. dollar terms, the S&P 500 declined 20%, very similar to the 21% decline for the TSX. 2. All but two Canadian sectors had lower losses than the U.S. The exceptions were Consumer Discretionary (Amazon) and Health Care (U.S. drug companies could benefit from medications for COVID-19).
“You Can’t Always Get What You Want” There is tremendous uncertainty about the timing and shape of the looming recession and subsequent recovery from the COVID-19 pandemic. How deep and how long the recession will be is unknown. The numbers are being revised frequently. We do know the second quarter will be hit especially hard. Will businesses and consumers increase savings and reduce spending after the massive, sudden loss of jobs? This would hold back the recovery. Will they go on a spending spree due to pent up demand? Unprecedented government stimulus (equal to about 10% of GDP) in Canada and the U.S. will support the economy and boost the recovery. Central bank rates will stay low until COVID-19 is under control and the economy has recovered from the shutdowns. Increased government debt will be an incentive to keep rates lower for longer.
Uncertainty around the economic outlook has made corporate earnings very difficult to predict. In fact, analysts have been slow to update estimates and many companies are no longer providing guidance for 2020. Earnings are a key component in developing our forecast for the stock market. We normally consider four different scenarios however, at this time, our approach is yielding a wider range of outcomes than usual.
“Paint it Black” When will stocks get out of the red and into the black? The TSX Composite started the year at 17,063 and the S&P 500 at 3231. We could reach these levels, possibly surpass them, by the end of 2020 if the shutdowns end this summer and the recovery is rapid and robust. If the closures last into the fall or another round of shutdowns is required late in the year due to a second outbreak, we could see markets end the year closer to the March 31st levels of 13,379 (TSX) and 2585 (S&P).
“Brown Sugar” Dividend yields are sweet--4% for the TSX versus .7% for ten year Canada bonds. From a valuation standpoint, stocks are attractive and we expect them to outperform bonds in the medium term.
Song Titles/Album Titles—The Rolling Stones