When discussing the economic changes that the COVID-19 pandemic has brought about, much attention is given to the tangible differences we observe around us. The transition en masse to work-from-home has caused distortions in everything from technology hardware demand to energy prices to suburban and commercial real estate markets. Consumers previously uncomfortable with online shopping have quickly become avid users. However, for Forstrong investment strategies, we identify three key structural changes that will have an outsized impact on returns for years to come.
During the economic recovery over the past decade, monetary policy has been relied upon nearly exclusively to support growth. Without receiving much assistance from government spending, central banks worldwide veered into unorthodoxy. Thus, the engagement of fiscal stimulus emanating from the global pandemic is a significant development; signalling the beginning of a “Keynesian” macro environment. The simultaneous deployment of fiscal and monetary policy accommodation provides a more potent and balanced means to boost economic activity. Coordination amongst the two channels is likely inevitable, meaning that Modern Monetary Theory (MMT) policies are visible on the horizon.
The US dollar carries an outsized importance to global financial markets, being the world’s reserve currency and the medium of exchange for a significant proportion of global trade. US dollar over-valuation is not a new phenomenon, as the sharp appreciation of the currency against global peers in 2014-2015 pushed the currency to a lofty level. However, per the chart below, the dollar (and currencies in general) tend to move in long cycles and can endure extended periods of over and under-valuation. It may be too early to truly declare a US dollar bear market, as the trade-weighted dollar is only down approximately -3% year-to-date and -10% from its late-March high. However, the dollar now faces numerous headwinds. A global economic recovery would be dollar-negative as the currency tends to be counter-cyclical. US interest rates have fallen sharply, eroding the dollar’s carry-trade advantage. Lastly, periods of US budget deficit expansion have historically weighed on the dollar.
US treasury interest rates have converged down towards the vast majority of developed market government bonds; now offering negative real yields across all maturities. US yields have not been overly attractive for some time, but the psychological implications of losing purchasing power over the life of one’s investment should not be understated. Investors buying government bonds for a stable source of portfolio income face the reality that such investments are neither stable (as yields have considerably more upside than downside risk) nor income-enhancing (as most national equity markets have higher dividend yields).
So what conclusions can be drawn from these structural shifts? The long-term ramifications of ultra-accomodative MMT-type policies may be negative, but in the short-term, they should be highly supportive of corporate earnings and equity valuations. A weak US dollar provides a tailwind to economies outside of the US (particularly emerging markets who borrow extensively in dollars). Investors looking to add ballast to their portfolios may need to look beyond traditional safe haven asset classes such as the US dollar and US treasuries. Critically, portfolio construction must adapt to the new realities in government bond markets; namely elevated risk and insufficient income. Accordingly, corporate exposures (both equities and bonds) will need to be more heavily relied upon.
GLOBAL STRATEGY OVERVIEW
Cash remains attractive as a portfolio diversifier and volatility dampener in what will likely continue to be an unsteady period for financial markets. However, the yield on cash and equivalent assets is now at rock-bottom levels, meaning inflation will take a larger than usual bite out of purchasing power. Weighing the above points against one another, we have elected to keep cash near neutral levels in client portfolios.
It may seem counter-intuitive that high yield spreads are near historical averages, despite sharply rising default rates. However, the US sub-investment grade market is being supported by numerous factors. The Federal Reserve has included high yield bonds in their asset purchase program. Additionally, strong demand for income has allowed issuers to refinance at more attractive rates and extend maturities further out into the future. We have increased our overweight positioning in US high yield bonds in client portfolios.
With a new economic cycle likely afoot, we continue to view cyclically-oriented sectors as beneficiaries from the current macro environment. US equity performance has been highly concentrated in technology and consumer discretionary sectors (particularly the “FAANG” stocks) this year; failing to meaningfully broaden into “real economy” sectors. We see considerable upside in the US industrials sector, and have moved to an overweight exposure.
The EU recovery package should have an outsized impact on Sweden and Poland, as both nations have manufacturing-centric economies deeply ingrained in the European supply chain. With numerous “false starts” for European growth in recent years, the key missing ingredient – fiscal policy – appears to have finally been triggered. We have added Swedish equities to our Special Opportunities Focus strategy this quarter and increased exposure to Polish equities in balanced and growth-oriented strategies.
Gross-of-fees performance ($CAD) as of September 30, 2020. Returns for periods greater than 1 year are annualized.
Performance statistics for ETF Managed Portfolios are calculated from documented actual investment strategies as set by Forstrong’s Investment Committee and applied to its portfolios mandates, and are intended to provide an approximation of composite results for separately managed accounts. Actual performance of individual separate accounts may vary with average gross “composite” performance statistics presented here due to client-specific portfolio differences with respect to size, inflow/outflow history, and inception dates, as well as intra-day market volatilities versus daily closing prices. Performance numbers are net of total ETF expense ratios and custody fees, but before withholding taxes, transaction costs and other investment management and advisor fees. Past performance is no indication of future results. A rate of return for one year or less is not annualized.