May 29, 2020
Making Cents of the Markets
Be in the Know
The old adage, “sell in May and go away”, couldn’t have been more misleading this year as markets continued heading higher off of the lows and finished the month and week in a strong manner. Both Canadian and US markets closed up over 2% on the week as investors remain positive on vaccine hopes, re-opening efforts, and pent-up demand which has started to be seen by large US retailers like TJ Maxx. There are 10 vaccines in clinical evaluation and over 100 in pre-clinical evaluation so investors are confident that a vaccine will be found in the coming months. We cannot disagree with this optimism as things can get better over the coming months but believe that investors may be overly cheerful in how fast the economy returns back to “normal”.
One concern we had on the market last week was the lack of participation in economically sensitive sectors like financials, energy, and industrials only to see them lead the market higher this week. This is a very positive sign for the S&P 500, the main US market, which was able to re-take its 200-day moving average and record another bullish signal. These recent developments have led us to believe that there is a low chance that we re-test the lows in March and that any future pullback in a “W-shaped” recovery will be shallower than initially expected. The sheer strength of the market cannot be ignored despite concerns around the future economy as it the market can continue to head higher. We have always stated that the market is the best leading indicator for the economy thus take these signals seriously while remaining disciplined in what we buy and sell at today’s prices.
If one looked at the markets this week, they wouldn’t have guessed that Canadian 1st quarter GDP came in at -8.2% which was slightly better than the -10% expected decline. Economic data simply has not mattered over the past month as investors choose to look forward understanding that worst was likely behind us. In the spirit of looking forward, we remain optimistic but cautious due to how disruptive COVID has been to the global economy, how fractious US-China relations are becoming (again), and how the upcoming election in the US is shaping to be another display of partisan politics that could possible end with a change in leadership that favors higher taxes. As Warren Buffet famously stated, one should be fearful when others are greedy and to be greedy when others are fearful.
As markets continued to show us strength and confidence in the future economy, we added more equity exposures in strong leaders within consumer discretionary and information technology. These growth-focused sectors have led the market higher thus we believe they will continue to lead as consumer spending returns back to healthy levels. We are near our target equity allocations which are lower than they were a year ago as we realize that the economy still has many hurdles to get over.
We always want to take less risk than the markets to the downside which is why we still value our higher cash holdings and defensive exposures in consumer staples and telecoms. We still have not allocated any significant capital towards financials, energy, or real estate as we believe that these sectors will see transformations over the coming year due to headwinds created by the pandemic. Asset allocation, or allocating effectively to certain sectors over others, has been proven to be a better source of future returns than the specific companies’ one invests in which is why we pride our ability to do both in an effective manner.
Chart of the Week
We have spoken on market valuations in the past month and are focusing on this again as the market has discounted the relatively high valuation that it is currently trading at. While valuations are not an accurate predictor of near-term market returns, they are a great predictor of long-term returns which is why we are only buying companies today that we believe trade at attractive valuations. Below is a chart of the S&P forward 12-month valuation which is an estimate of where valuations are today when taking into account the expected earnings growth over the next year:
As one can see, markets are trading at future valuations that have not been seen since the early 2000s at 21.8 times future earnings. Alone this would indicate that the market is “overvalued” yet it may not be that rich once one takes into account low interest rates and the likelihood that estimates will likely increase as the re-opening picks up steam.
Beyond the Markets
With June just around the corner, BC continues to ease restrictions on various businesses and activities across Metro Vancouver. We are now seeing an increasing return to a sense of normality with many restaurants and stores reopening. Cities across the province have also announced the reopening of numerous national parks, playgrounds, and outdoor facilities, so it will be a great time to get out and move around! We encourage those who are able to, to take advantage of the easing restrictions but also practice COVID-19 safety protocols such as washing your hands and staying two metres away from others. Have fun and stay safe!
Listen to our latest Making Cents of the Markets segment on CKNW. We discussed Canadian Bank earnings, estate planning, and how to invest inheritance money. Listen here.
Take a look here at our most recent North Shore News article where we discuss the importance of active investing and how it compares to passive investing.