by Alfred Lee, CFA, CMT, DMS Director, BMO ETFs Portfolio Manager & Investment Strategist BMO Asset Managment
Highlights
• After experiencing one of the most vicious sell-offs in market history, risk assets quickly bounced back over the second quarter, despite ongoing concerns of a second COVID-19 wave. Over the quarter, the S&P/TSX Composite, S&P 500 Composite and the FTSE/TMX Canadian Bond Universe are all up 20.0%, 18.6% and 6.2%, respectively, on a total return basis in local terms.
• Many investors have watched from the sidelines, however, questioning the validity of the rally. While the shape of the economic recovery is up for debate, investors should note that a large part of the sell-off in March was due to a lack of liquidity. During the onset of the economic shutdown, desperation increased as investors were willing to take any bid, leading the markets to gap lower. Since then, central banks have added a number of liquidity measures to provide a backstop to the market. These measures would make a notable impact should we experience a retracement in risk-assets due to a resurgence in coronavirus infection rates.
• In March, there was significantly more uncertainty in terms of the actual COVID-19 mortality rate, but with more data now in hand, another shutdown of the economy would be unlikely even in the absence of a vaccine. This is because improved testing and analytics can potentially be used to better manage infections within the population. The greater concern heading into the latter half of the year that could likely disrupt markets is growing civil unrest around the globe, and the upcoming U.S. presidential election.
• The futures market seems to be in agreement that volatility may return in the Autumn, as the CBOE Volatility Index® (VIX) term structure currently peaks with October contracts (Chart A). While risk assets have rallied considerably in recent months, investors should remain prudent and have core exposures dedicated to low volatility and quality assets in their portfolios. High-beta stocks typically outperform coming off market bottoms, but their momentum typically wanes as euphoria fades. Already, we are seeing the relative strength of high-beta stocks weaken against their lower-beta counterparts (Chart B).
• The U.S. dollar (USD) index has also come down considerably since mid-March, as USD funding needs have decreased considerably. This has been a result of a decline in central bank usage of USD swap lines in recent months, a further indication that liquidity has been restored. We would still maintain some USD exposure in a portfolio for diversification purposes, however, as the Canadian economy still faces some headwinds such as lower oil prices.
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