January 27, 2021

Financial letter, Winter 2020, 54^th edition

And yet 2020 started off so well...

The détente in the trade wars offered hope that international commerce would return to normal and the manufacturing sector would gain momentum. The employment market was in good shape, while unemployment hit historic lows and wage increases jacked up consumer confidence. In turn, robust sales boosted hiring and investment, creating a virtuous circle. Furthermore, financial conditions stayed extremely easy after the US Federal Reserve abruptly reversed course in 2019. In short, 2020 was shaping up to be a good year, but that was before COVID-19.

However, if we’d known ahead of time everything that the pandemic would entail, we may not necessarily have made the right investment decisions. If you’d been told that the worst public health crisis in modern history was about to strike, would you have wanted to invest? If you’d been told that we'd plunge into a recession of an unprecedented breadth and at an unprecedented speed, would you have believed that it was a great opportunity to invest? If you’d been told that governments were going to run heretofore unheard-of deficits to fight this invisible enemy, would you think conditions would be ripe for taking risks? But a balanced portfolio returned nearly 10.50% (before fees) in 2020, after jumping nearly 13.50% (before fees) in 2019.

Although advance knowledge of how events would unfold over the last 12 months would have proved useless, investment manuals can still cite last year as yet another example of how important it is to have a plan and stick to it.

Fixed income and interest rates

Central banks remain determined to maintain highly favourable financing conditions to bolster the economy during the second wave. They’re expected to keep key interest rates at their effective lower bound until 2023.

Expectations regarding fixed income should therefore remain extremely modest since it will be almost impossible to generate past yields. From this point forward, most of the bond market's value could very well lie in its negative correlation with stocks and the protection it provides against them, especially in bear markets. This means longer government bonds are expected to rise in value if equity drops, and therefore can be sold off to buy higher-potential stocks while they're at a discount.

In terms of strategy, bonds are slightly underweighted in the portfolio due to their valuations. We are keeping the portfolio's duration at 4.5 years, in keeping with our benchmark index.

Portfolio strategy

Over a 12- to 18-month horizon, the expected return on equities is higher than on bonds and cash. Of course, high equity valuations should result in lower future returns compared to recent performance. However, the prospect of vaccines and a lasting economic recovery is encouraging investors to take more risks. But expectations must be managed, since the current high multiples will limit the momentum generated by expected earnings growth.

Let’s be honest: If you look at stocks on their own merits, they’re not affordable at all. True, they've been more expensive at times, but they're still well above historic ratios. Nevertheless, they remain more appealing than other asset classes. In an environment where inflation could surprise to the upside, equity generally offers some protection.

A good selection of stocks that have been carefully chosen based on region, sector and investment style is required.

Geographic allocation

Canada | Neutral

Canada plummeted into this recession unexpectedly and many people saw it as the ultimate test of the weaknesses related to household debt and high real estate valuations. But unlike previous recessions, households didn’t see their income fall. In fact, it went up. In addition, contrary to what CMHC expected, house prices didn’t fall. They climbed instead. This means that the expected pressure on banks may not be as strong as people thought it would be. As a result, all of the provisions for bad debt that were set aside earlier this year could end up turning into extraordinary gains. In addition, the expected depreciation of the US dollar seems promising for commodities and raw materials. Consequently, we’re raising our Canadian allocation from “underweight” to “neutral”.

United states | Overweight

The US market can’t always lead the way. But its concentration in technologies, telecommunications and healthcare means that structurally it's a prime market. Of course, over the short term, a normalization of economic activity could give “value” sectors a shot in the arm, to the greater benefit of foreign stock markets. But, after the initial jump, investors will see a return to normal that results in more modest growth, in which businesses that are more dynamic in this respect will earn a premium.

Europe | Underweight

Investors have been patiently waiting for Europe's economy to take off for years. Every time it seems to be speeding up, it's held back by the euro's appreciation. Governments and the European Central Bank may very well keep the pedal to the metal, but economic growth just doesn’t seem to be gaining any lasting momentum. A recovery is in sight, but it won’t be enough to tip the balance in favour of the EURO STOXX in 2021. We’ll continue to recommend underweighting Europe in a well-diversified portfolio.

Emerging markets | Overweight

We strengthened our recommendation on emerging markets this year when the US dollar began to drop. Not only do we expect this phenomenon to continue, but companies based in emerging markets tend to do well when the global economy accelerates. Consequently, winning the fight against COVID-19 and a return to normal for global economic data bode well for the future.

2020 will go down in history as a year of immense socioeconomic upheaval. But despite everything, the devastating effect of the pandemic will have helped speed up a structural change that's rife with opportunity. Increased public awareness of the importance of buying local, the way work is organized, income inequality and the environment will have a lasting impact. It looks like 2021 will be a good year, as long as we manage to defeat or at least contain COVID-19.

For investors with a sufficiently long investment horizon, the biggest risk isn’t temporarily losing money, it’s not having enough. Consequently, there’s still no alternative to holding a well-diversified portfolio.

Investment manuals will use 2020 as yet another example of how important it is to have a game plan and stick to it. To win at this game, you can’t just be a part-time investor. You have to dedicate yourself to it full-time.

We hope this provides you with additional market insight. We’re always available to discuss our investment strategies with you at greater length. We remain committed to working even harder to identify promising market opportunities to help you achieve your long-term goals.