JCIC Market Outlook: September 2020
The first nine months of 2020 have presented investors with an extraordinary combination of economic disruption, market volatility and government intervention.
COVID-19 has affected consumer behaviour, travel, manufacturing and global supply chains. Central banks have responded with lower interest rates and renewed quantitative easing, while governments have introduced significant fiscal support for households and businesses.
Against this uncertain backdrop, JCIC continues to combine a broad view of the global economy with detailed company analysis. Our focus remains on protecting client wealth, identifying attractive long-term opportunities and managing risk through changing market conditions.
How Does JCIC Approach Investment Management?
JCIC’s investment process combines top-down economic analysis with bottom-up company selection.
Our top-down work considers the global economy, monetary and fiscal policy, relative valuations and the attractiveness of different asset classes. We assess cash, fixed income and equities, as well as opportunities across Canada, the United States and international markets.
Client return objectives and risk tolerance also remain central to portfolio construction.
Our bottom-up research focuses on the individual companies held within each portfolio. We primarily invest in mid- to large-capitalization businesses, with an emphasis on companies that pay dividends and demonstrate financial strength.
Portfolio construction considers the balance among defensive, cyclical, growth and interest-rate-sensitive investments. The objective is not simply to maximize return. It is to pursue attractive risk-adjusted returns while protecting the capital clients have worked to build.
What Does JCIC Look for in a Company?
Our company research considers both financial and non-financial factors.
We examine the visibility of the business, free-cash-flow generation, earnings growth, balance-sheet strength, return on equity and shareholder remuneration. We also assess management’s track record, competitive positioning, industry conditions and the company’s ability to navigate changing economic circumstances.
Valuation remains critical. A high-quality company can still be an unattractive investment when its share price already assumes overly optimistic growth.
We therefore compare the company’s potential upside with the risks surrounding revenue, earnings and valuation. We also monitor changes to analyst expectations and whether the investment outlook is improving or deteriorating.
Environmental, social and governance factors, as well as the United Nations Sustainable Development Goals, are becoming additional inputs into this analysis.
What Is JCIC’s Economic Outlook?
The global economy experienced a severe decline during the first half of 2020 as governments introduced lockdowns and restrictions to slow the spread of COVID-19.
The depth of the disruption has been significant, and the shape of the recovery remains difficult to predict. Supporting factors include a healthier financial system than the one that entered the 2008 financial crisis, aggressive central-bank intervention and substantial government stimulus.
The U.S. economy entered the pandemic with strong employment, improving wages and a healthy consumer. Economic momentum then weakened dramatically as activity was restricted. The Federal Reserve responded by reducing interest rates, relaunching quantitative easing and supporting financial-market liquidity.
Canada has also been affected by the economic shutdown and the additional shock of weak oil prices. We expect activity to improve from the depressed levels recorded earlier in the year, although the recovery is unlikely to be even across industries.
European economies experienced severe weakness during the first half of 2020. Europe’s reliance on global exports created an additional challenge as international demand declined. Fiscal expansion, low interest rates and quantitative easing should support the recovery as restrictions ease.
China experienced a sharp contraction early in the year. Manufacturing activity has resumed, but cautious consumer behaviour and weakness in the global economy remain headwinds.
Japan continues to maintain highly accommodative monetary policy and has introduced a substantial stimulus program, although economic growth is expected to remain negative for the year.
How Is JCIC Positioning Client Portfolios?
JCIC entered the period with a defensive approach to asset allocation.
At the time of this outlook, portfolios are generally:
Market weight in equities
Underweight fixed income
Overweight cash
Tilted toward defensive companies
Within equities, we have also used periods of broad market weakness to purchase higher-quality companies at more attractive prices.
The market decline in February and March affected strong and weak companies alike. As conditions stabilized, we began selectively reducing cash and increasing exposure where earnings expectations appeared to be bottoming.
We remain cautious because equity markets have recovered more quickly than corporate earnings. Current valuations appear to reflect a stronger recovery than we can confidently forecast.
Within fixed income, portfolio duration remains modestly shorter than the benchmark. We favour corporate bonds over government bonds because credit spreads offer better potential return.
What Is JCIC’s Fixed-Income View?
Bond markets performed better in 2019 and during the first part of 2020 than we expected, largely because concerns about global growth drove yields to very low levels.
From a longer-term perspective, however, the potential for strong fixed-income returns appears limited.
We remain overweight cash and underweight bonds. Corporate bonds represent a larger share of our fixed-income exposure than they do in the benchmark because we believe they offer more attractive return potential than government debt at current yields.
The purpose of the fixed-income allocation remains capital preservation, income and portfolio stability. But extremely low interest rates reduce the return investors can reasonably expect from traditional bonds.
What Is JCIC’s Equity-Market View?
We are maintaining a market-weight position in equities, but with a defensive bias.
The outlook will depend heavily on progress in controlling COVID-19, the development of vaccines and treatments, the recovery in corporate earnings and the outcome of the U.S. presidential election.
Defensive companies have generally performed better than businesses most directly affected by the pandemic. More recently, some of the hardest-hit stocks have begun to recover as investors look for signs that earnings expectations have reached a bottom.
We have used the volatility to improve the quality of the companies held in client portfolios. We are also gradually moving from a highly defensive stance toward a more balanced position where valuations and improving earnings visibility support the decision.
The market recovery has been concentrated in a relatively small group of large companies. Technology businesses and other firms benefiting from long-term structural trends have been especially strong.
This narrow leadership makes the performance of the major indexes appear stronger than the experience of the average company.
If the economic recovery becomes more firmly established, we would expect investors to show greater interest in companies and sectors that have lagged behind but offer improving earnings and more attractive valuations.
What Risks and Opportunities Could Affect Markets?
Several positive and negative forces are influencing markets.
Investors are balancing rising COVID-19 cases, political tensions, weak earnings and elevated valuations against extraordinary monetary and fiscal support, low interest rates and signs that economic activity is recovering from deeply depressed levels.
The reopening of economies has produced an initial rebound. The longer-term recovery may be less direct.
Rather than a simple V-shaped recovery, the path could resemble a square root or elongated swoosh: a sharp initial improvement followed by slower progress before activity fully returns to previous levels.
The pace will vary across countries and industries.
Countries that controlled infections more effectively have generally been able to reopen more successfully. Other regions continue to face high case numbers, renewed restrictions and pressure on consumers and businesses.
What Is JCIC’s View of Global Trade Tensions?
A broader global trade conflict remains a long-term market risk.
The United States has imposed tariffs or threatened trade action involving China, Europe, Japan, Canada and Mexico. Although several agreements have been reached, trade tensions continue to reappear.
The Phase One agreement between the United States and China was signed in January 2020 and included some tariff reductions and commitments by China to purchase U.S. goods.
However, many tariffs remain in place. COVID-19 and rising political tensions have also made it more difficult to determine whether the agreement will meet its objectives.
A more comprehensive Phase Two agreement appears uncertain. Significant disagreements remain concerning intellectual-property protection, regulation, enforcement and the trade deficit.
We expect relations between the United States and China to remain strained as China’s economy continues to grow and compete more directly with the United States.
A prolonged trade conflict would be negative for global economic growth and equity markets.
Which Sectors Is JCIC Favouring?
We have been moving toward a more balanced mix of defensive and economically sensitive investments.
In Canada, we reduced exposure to some of the most cyclical areas, including non-gold materials and energy producers, earlier in the year. We increased exposure to gold, pipelines, infrastructure and other investments offering greater earnings visibility.
Defensive sectors are not always inexpensive, but their earnings have generally been more resilient during the pandemic.
In the United States, we favour companies benefiting from long-term structural trends and holding leading competitive positions.
Within international equities, we maintain meaningful defensive exposure and have reduced holdings in businesses that are more vulnerable to the pandemic.
The balance between defensive and non-defensive sectors will continue to depend on valuation, earnings visibility and the pace of economic recovery.
How Could the U.S. Election Affect Markets?
The U.S. presidential election is scheduled for November 3, 2020.
At the time of this outlook, polling and betting markets favour Joe Biden over President Donald Trump, although the race continues to evolve.
A Biden administration could seek to reverse part of the corporate tax reduction introduced under President Trump. Other proposals include higher taxes for individuals earning more than US$400,000, increased infrastructure spending, clean-energy investment and a higher federal minimum wage.
Higher corporate taxes could reduce S&P 500 earnings. However, several factors may soften the impact.
The weak economy may delay significant tax increases. Infrastructure spending could support economic growth and benefit selected industries. Low interest rates also continue to make equities relatively attractive compared with bonds.
A weaker U.S. dollar may provide additional support to American exporters and multinational companies earning revenue outside the United States.
At first glance, some elements of a Biden presidency may appear negative for equities. The final market impact will depend on Congress, the timing of policy changes, the strength of the economy and the amount of additional fiscal support.
How Does JCIC Consider ESG and Sustainable Development Goals?
Environmental, social and governance issues have become a growing part of investor and corporate agendas.
JCIC does not currently operate a dedicated ESG or Sustainable Development Goal mandate. However, we incorporate relevant ESG and SDG factors into our broader company analysis.
Environmental considerations may include carbon emissions, energy consumption and water use. Social considerations may include labour standards, workforce diversity and data security. Governance analysis may examine board structure, executive compensation, bribery risk and the separation of the chief executive and board-chair roles.
Companies may rank strongly in some areas and poorly in others. Businesses that perform poorly across all major ESG categories are less likely to qualify for JCIC’s approved list of securities.
The United Nations Sustainable Development Goals provide another framework through which companies can assess progress involving clean energy, health, education, infrastructure, climate action and responsible consumption.
What Is JCIC’s Foreign-Exchange Policy?
JCIC does not currently hedge foreign-currency exposure.
The largest exposure is to the U.S. dollar, although portfolios also hold international companies in Europe and Asia. We are examining the possibility of adding currency-hedging capability to the pooled funds.
The Canadian dollar weakened sharply earlier in 2020 as oil prices collapsed and concern about the economic outlook intensified. It later recovered as risk sentiment improved, oil prices rebounded and the U.S. dollar weakened.
Further appreciation in the Canadian dollar may occur if the economy continues to recover and commodity prices improve.
However, low interest rates, high levels of consumer debt and uncertainty surrounding the pace of recovery could limit that move.
Staying Disciplined Through an Uncertain Market
The economic and market outlook remains unusually uncertain.
COVID-19, fiscal and monetary policy, political developments, trade tensions and the recovery in corporate earnings will continue to influence investor sentiment.
JCIC’s response is not to rely on one economic forecast.
We continue to combine global market analysis with detailed company research, disciplined valuation and active portfolio construction. We are maintaining a defensive foundation while selectively adding high-quality companies where improving fundamentals and attractive long-term value support the investment case.
Protecting client wealth remains the priority.
For a current explanation of how JCIC evaluates investments and builds portfolios, explore Our Investment Process and Portfolio Management.
Explore JCIC’s Investment Approach
JCIC combines global economic analysis, detailed company research and disciplined portfolio construction to protect and grow client wealth over time.
Disclosure: Although we obtain information contained in our newsletter from sources we believe to be reliable, we cannot guarantee its accuracy. The opinions expressed in the newsletter are those of JCIC Asset Management, its editors and contributors, and may change without notice. Any views or opinions expressed in the newsletter may not reflect those of the firm as a whole. The information in our newsletter may become outdated and we have no obligation to update it.
The information in our newsletter is not intended to constitute individual investment advice and is not designed to meet your personal financial situation. It is provided for information purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment is suitable for a particular investor or a group of investors. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable.
We strongly advise you to discuss your investment options with your Relationship Manager prior to making any investments, including whether any investment is suitable for your specific needs.
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