Because you asked: COVID-19 edition
Answering your top investment questions for a market recovery
Based on Investments Unplugged podcast 38A — Philip Petursson, Kevin Headland, and Macan Nia with Manulife’s Capital Markets Strategy team answer your top questions as we head into the second half of 2020.
— Albert Einstein
Learn from yesterday, live for today, hope for tomorrow. The important thing is to not stop questioning.
A lot of Canadian investors rely on stock dividends for income, but there are concerns about dividend cuts, especially regarding bank stocks. What are the risks?
The Capital Markets Strategy team believes that Canadian investors don’t need to worry about big five bank dividend cuts. In fact, bank dividends have stayed strong since 1940 with no cuts. Currently, Canadians own about 90 per cent of the bank shares — up to 50 per cent are retail investors who rely on dividends as a source of sustainable income.
There are other cost-cutting options that would happen before banks would consider cutting dividends. If they didn’t feel the need to cut the dividend in 2008/09, where there were numerous dividend cuts by American banks, we believe Canadian banks will be less likely to make these types of cuts this time around as well.
Should we get to the point where we have widespread mortgage defaults among Canadians, the impact to banks isn’t as great as many people may fear. This is because at-risk mortgages are insured by the Canada Mortgage and Housing Corp (CMHC) and wouldn’t show as a loss on a bank’s balance sheet.
Why does it seem like market recovery has only occurred in a few sectors?
There’s a misperception that we’re experiencing a narrow market rally, rather the Capital Markets Strategy team sees this as a broad-based rally. What’s surprising is the speed at which the market rallied back from the March lows, and that can be attributed to the quantitative easing support from the U.S. Federal Reserve. As of mid-June, we’ve seen the market rise about 35 per cent from the March 23 market low.
While tech giants such as Facebook, Amazon, and Apple may capture the headlines, there are solid gains across all sectors. When we examine the S&P 500 and look at it from an equal-weighted basis, versus market cap weight, the equal weight is performing roughly in line, implying that this isn’t a handful of names driving the market. The gains off the low have been fairly broad-based. That may be surprising news for a lot of investors, but this is truly a broader market recovery that goes beyond tech.
Given the response to COVID-19, we’ve seen unprecedented amounts of stimulus. In Canada, that has come in the form of federal government Canada Emergency Response Benefit (CERB) spending in the range of $60 billion and climbing, with more federal stimulus expected in the coming months. What impact will this debt have on investments?
This may come as a surprise, but government debt has very little impact on stock market returns. There could be an impact on bond holdings if there’s a significant rise in interest rates — typically as interest rates go up, bond values go down. Central bank efforts are working to make sure that interest rates stay low for the foreseeable future. So, while record debt levels can affect certain sectors of the economy, history shows that high government debt levels don’t tend to impact investments. The effect of federal debt on taxation rates and consumer spending habits is another story.
What’s the expected impact of high federal debt levels on the dollar?
With unprecedented levels of financial and monetary stimulus, there’s the potential for the U.S. dollar to weaken. There tends to be a correlation between rising U.S. deficit and a weaker U.S. dollar. Canadian investors with holdings in U.S. dollar denominated securities may feel some impact as a consequence of a weakening U.S. dollar but we don’t believe it’ll be meaningful enough to completely offset potential U.S. equity market gains over the coming 18 months.
Why has the Canadian dollar rebounded so strongly versus the U.S. dollar?
At the beginning of the pandemic some predicted a weaker Canadian dollar in the range of US$0.60, along with an overall weaker economy as consumers deal with higher debt levels. However, we believe the Canadian dollar is largely a petro-currency.
When oil prices dropped into negative territory in April, the Canadian dollar didn’t follow suit and we feel that’s because no one believed oil prices would stay negative. April’s negative drop is considered an anomaly caused by speculators and storage. As demand for crude plummeted due to the coronavirus pandemic, inventories were rapidly building. In response, production levels were cut, oil prices began to recover, and through it all, the Canadian dollar remained stable. Since then, oil prices have been recovering nicely, and we anticipate oil prices will go higher due to a tighter oil supply and greater demand.
According to recent figures from the International Energy Agency, comparing oil supply and demand for April and May 2020 to the same months last year, demand only fell by eight million barrels a day globally. At the same time, OPEC cut its supply by 6.6 million bbl/d and other suppliers such as the U.S., Norway, and Canada cut their supplies by 4.7 million bbl/d. We believe there’s potential for even higher prices with stronger demand and less supply as business returns to a more normal pace and travel increases.
Over the next six to 12 months, our projections based on output and demand pegs oil prices at US$40 to US$45 a barrel, with the Canadian dollar at US$0.75 to US$0.77.
Why should I invest in high-yield bonds rather than equities, and have I missed the opportunity?
High-yield bonds can be viewed as a stepping-stone away from equities towards a more defensive position. High yield typically suffers 50 per cent of the downside of equities with close to 100 per cent of the upside through recessionary bear markets. And high-yield bonds can be used in the opposite manner, to be the bridge from a very defensive core bond position back into equities. Currently, the Capital Markets Strategy team has its model portfolio set at 60 per cent equities and 40 per cent fixed income, with 15 per cent of the bond allocation geared to high yield.
We look at the current one-year return on high-yield — at about 7 per cent, which can be considered quite a good return for a product designed to balance against the downside. And the protection is in place if there’s further market turbulence. If you’re looking to high yield as an income generator, there’s still good opportunity in this space, with most products offering mid-single digit returns. But it’s important to know your reasons for considering high yield. Is it for price, income, capital appreciation, or a combination of these factors?
What is the impact of global political issues on money markets?
Over the past decade, there’ve been numerous conflicts and situations that have held serious weight, including tensions with North Korea, the African Ebola outbreak, the invasion of Crimea, and more. But the short answer is that geo-political issues don’t tend to have a big impact on market performance. The challenge is the emotional impact that investors may have to news headlines that could affect their investment decision making.
In the U.S., with a presidential election set for November 2020, history shows that it’s not so much the party with the presidential seat, Congress, or the Senate, but rather government policies and the valuation of the stock market that tend to be the main forward drivers for market performance. Over the long term, the person who sits in the Oval Office has little impact on market returns.
Some interesting statistics come from looking at politics and market performance:
- During the fourth year of a first-term president, the average return on the S&P 500 is about 14 per cent.
- A strong economy tends to be a contributing factor for a presidential re-election.
- Aside from assassinations, impeachments, or resignations, only twice has a president only had one term since 1945 — Jimmy Carter (’76–’80) and George Bush, Sr. (’88–’92).
- Only once has a political party won three successful mandates. That was the Republican party, with Ronald Reagan serving two terms (’80–’88) and George Bush, Sr. (’88–’92).
It’s worth a reminder that despite who’s in the White House, each four-year period has its own unique set of challenges based on interest rates, valuations, inflation rates, and central bank policies. More than politics, what drives market returns are investing fundamentals, earnings, and valuations.
Ultimately, what drives stock prices is a company’s ability to turn a profit, and it will take time to see if earnings projections factored into this market recovery are realized.
Philip Petursson, CIM
Chief Investment Strategist and Head of Capital Markets Research
Support materials on market volatility, the value of advice, and the importance of staying invested can be found in the Viewpoints section of Manulife Investment Management Canada.