”It’s health that is real wealth, not pieces of gold and silver.”
- Mahatma Gandhi
Equities rallied in July for the fourth straight month, a reflection of market confidence that the economy is on the mend from COVID-19 shutdowns that started in March.
As August began, gold prices rocketed above US$2,000 per ounce for the first time in history, up over 30% this year. The yellow metal typically benefits from falling interest rates and increased uncertainty – conditions that have dominated markets in 2020. Although demand for gold jewelry has been weak, investor demand has been strong. Gold is up because it is considered a store of value (an asset that retains its value without depreciation) and a hedge against inflation.
Technology was the only sector that shone as brightly as gold; its strength helped offset weakness in other sectors of global stock markets. July also saw the Nasdaq Composite Index set new records.
Markets continued to shrug off the risk of more economic shutdowns, despite several global outbreaks and a terrifying surge of infections in the U.S. Between July 1 and July 31, U.S. cases soared from almost 2.6 million to almost 4.4 million. More than 20 promising vaccines have moved into human trials, a hopeful sign that one or more will be ready to roll out by December.
Canada – Heart of gold
The pandemic gave Canada’s economy a thumping in Q2. Statscan’s preliminary estimates show a 12% contraction from Q1. On a positive note, May and June enjoyed month-over- month increases while we slowly emerged from full lockdown.
Our economy is contracting as expected, given the double whammy of COVID-19 and weak oil prices earlier this year.
Price Returns January 1 - July 31, 2020
(Normalized in U.S. dollars)
Improved oil prices, continued monetary stimulus from the Bank of Canada (BoC), and a resilient housing market will help us climb out of the hole.
Canadian stocks rose 4.2% in July and were among global top performers. A rally in gold and silver prices helped because gold and silver mining companies have a significant presence in the benchmark S&P/TSX Composite Index. Materials was the top performing sector for Canada – gold companies were up 15% and silver companies 24%.
Recent optimism about economic recovery helped the loonie rise 9% from March lows. Stronger oil prices also contributed. The outlook for the Canadian dollar will remain positive if we can slowly reopen our economy and successfully open schools
without triggering a second wave of infections.
The BoC maintained its overnight rate target at 0.25%. With inflation holding close to zero and economic recovery uncertain, the central bank said it is ready to leave its benchmark interest rate near zero for two years at least.
Canadian bonds also moved higher when interest rates fell on concerns that the economy will take longer than expected to get back to pre-coronavirus levels. The BoC plans to continue its bond-purchase programs, but will adjust according to market conditions. Interest rates have little room to fall beneath their current record lows, which is shaping the outlook for bonds.
Ottawa published its fiscal snapshot – an estimate ofCOVID-19’s impact on federal finances. A projected $343 billion deficit was much larger than expected, coming in at 16% of GDP, the largest shortfall on record. Overall revenue is projected to decline by more than 20% thanks to lower tax revenue.Canada’s debt will exceed $1 trillion. The market took this new information in stride, with minimal
impact on the loonie and our bonds.
United States – All that glitters is not gold
U.S. stocks enjoyed their largest four-month percentage gain since December 1998. In July alone, the S&P 500 Index appreciated 5.5%. Technology companies dominated strong returns in benchmark stock indices; the tech-heavy Nasdaq Composite Index posted a 56% return since the market bottomed in March.
Technology behemoths Facebook, Amazon and Apple all reported strong earnings for the second quarter. Their business models proved resilient despite economic contraction in Q2.
There were some bright lights in the U.S. economy. For example, in June, consumer spending (the primary driver of the U.S. economy) continued to rise; however, the U.S. economy as a whole is losing momentum. A resurgence of COVID-19 cases and subsequent rollback on economic openings dampened consumer confidence in July. Rising claims for unemployment benefits have taken a toll on business confidence. In the last week of July, new jobless claims came in at 1.34 million, the 19th straight week of at least one million new claims. TheU.S. unemployment rate fell in July to 10.2%, but remains significantly above the 3.5% low reached in February of this year.
After five months of fiscal support, the U.S. government was still negotiating its fifth relief plan for Americans. This could involve mailing cheques to citizens once again, or extending unemployment top-up benefits. Democrats and Republicans remained far apart on the proposed aid package, potentially delaying much-needed support for small businesses and laid-off workers.
The U.S. dollar continued to descend from its March peak, with the dollar index trading almost 9% lower than March levels. We can expect some greenback weakness while the global economy recovers, removing the safe-haven demand that fuelled its upward surge earlier this year. A weak U.S. dollar benefits U.S. exporters, but can also cause inflation when imported goods become more expensive.
As the sun begins to set on year four of President Donald Trump’s term, opinion polls are in the spotlight. They are pointing to a potential victory for Joe Biden and a Democratic sweep (the presidency and both houses of Congress). That scenario is prompting fears that a Biden victory will bring tax increases, which could cast a dark shadow over the economy at precisely the moment it
needs growth stimulus.
Europe and the U.K. – In search of Goldilocks
In Q2, eurozone GDP shrank by a record 12.1% compared with Q1. Europe’s largest economies suffered double-digit declines.
The European Central Bank (ECB) projects that GDP will decline almost 9% for 2020. A second-half recovery could hinge on the co-ordinated EU Recovery Fund – a coronavirus stimulus package worth 750 billion euros to help member states get back on their feet. Accommodative monetary policy will also be key for European recovery.
In July, the U.K. manufacturing Purchasing Managers’ Index (PMI) came in at a 16-month high of 53.3 – typically a reading above 50 indicates expansion. Brexit talks continued between the EU and Britain. With a target date of October 31 to reach a deal, both sides remain far apart on several issues.
China – Golden era
Chinese equities started strong in the second half of 2020 and were up 10.9% in July (measured by the Shanghai Composite Index).
While other countries struggle with the economic impact of COVID-19, China’s economy enjoyed a robust rebound in Q2. It escaped a technical recession, defined by two consecutive quarters of contraction, and expanded at an annualized rate of 3.2%. This impressive bounce back is evidence that China’s all-out lockdown approach early in the pandemic paid off.
Although the nation shows signs of recovery, its economy is not yet back to full strength. Beijing is growing concerned about the timing of its deteriorating U.S. relationship. In a speech, Chinese Foreign Minister Wang Yi said that the U.S.–China relationship faces its “most severe challenge since the establishment of diplomatic ties.” After this proclamation, the U.S. ordered the Chinese consulate in Houston to close, claiming a threat of espionage. In a tit-for-tat move, China retaliated by ordering the American consulate in Chengdu to shut down.
At least for now, this squabble has not affected their trade deal. It appears that neither side wants to endanger the trade truce they signed in January.
Japan – Losing its lustre
The Japanese government slashed expectations for economic growth to -4.5% for 2020, down from a forecast of 1.4% back in January. Japanese equities lagged their global peers; the Nikkei Stock Index was off -2.6% for July.
While Japan was initially lauded for avoiding a large COVID-19 outbreak, the nation saw a record number of daily cases in July. Prime Minister Shinzo Abe blamed the virus’s resurgence on reopened nightlife entertainment districts in Tokyo. He indicated that he was not concerned about hospitals being overwhelmed since the majority of cases are young people.
Despite new outbreaks, the government plans to go ahead with a US$10 billion domestic tourism promotional campaign aimed at providing aid to businesses hardest hit by the pandemic.Critics of the plan believe that Mr. Abe is promoting both economic growth and a second pandemic wave.
Our strategy
Equity markets and credit assets continue to ignore the potential risk of an economic setback. At the same time, government bonds are reflecting the recovery’s slowing pace. We see caution signals about the future as bond yields continue to sink.
Our base case assumes that the recovery may moderate but will continue its ascent throughout Q3. Interest rates are already very low and don’t have far to fall from this point, which means there is limited upside for bonds. The virus remains a threat. Many sectors, including travel and leisure, will not recover until there’s a vaccine or a cure. In the meantime, strong fiscal and monetary support across the globe continues to bridge the economic gap, bolstering equities and riskier credit assets.
Risks to the base case remain centred on the pandemic. Outbreaks could force a rollback in economic reopenings. Some regions have not yet been able to get the initial wave of cases under control. In the run-up to the presidential election, Mr.Trump’s penchant for unpredictable and dramatic action poses another potential geopolitical risk.
The last word
“Summer’s lease hath all too short a date.” We would be wise to heed Shakespeare’s words as we pass through the midpoint of summer, holding tightly to longer days and warm temperatures. We can pause to enjoy the golden glow that has infused the markets. Both equities and bonds have moved steadily higher over the last four months. The additional volatility that we expected has not materialized. Positive economic data offer welcome comfort after a tumultuous time of lockdown and uncertainty.
Information contained in this publication is based on sources such as issuer reports, statistical services and industry communications, which we believe are reliable but are not represented as accurate or complete. Opinions expressed in this publication are current opinions only and are subject to change. BMO Private Wealth accepts no liability whatsoever for any loss arising from any use of this commentary or its contents. The information, opinions, estimates, projections and other materials contained herein are not to be construed as an offer to sell, a solicitation for or an offer to buy, any products or services referenced herein (including, without limitation, any commodities, securities or other financial instruments), nor shall such information, opinions, estimates, projections and other materials be considered as investment advice, tax advice, a recommendation to enter into any transaction or an assurance or guarantee as to the expected results of any transaction.
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